Core inflation, though, has remained sticky at around 4 per cent for quite some time.
Minutes of the last review conducted on June 6-7 showed that five members of the MPC, including RBI Governor Urjit Patel, preferred a wait-and-watch approach. The members flagged sticky core inflation and wanted sure signs of food and fuel prices moderating.
The RBI kept its policy repo rate unchanged at 6.25 per cent in the June review.
Patel said there was “high uncertainty clouding the near-term inflation outlook”. RBI Deputy Governor Viral Acharya questioned whether a rate cut at this point would necessarily be useful for credit growth. Rather, his assessment was that banks’ books should be cleaned up first, which he last week said was the RBI’s priority now.
In this context, the current policy becomes challenging for the central bank and economists this time are clearly divided.
group chief economist Rupa Rege Nitsure said she was divided between a cut and the status quo. “Why would a central bank, which is sucking out excess liquidity through open market operations, like to reduce policy rates? Chances of the status quo are high, but a rate cut can be undertaken to soothe the investment sentiment,” she said.
Saugata Bhattacharya, chief economist of Axis Bank, said this time it would be a difficult decision.
Soumyajit Niyogi of India Ratings and Research said there would likely be a cut, but data volatility also called for applying the Brainard principle. In December 2013, then RBI governor Raghuram Rajan had cited William C Brainard’s theory on effectiveness of policy, stating, “When there is a lot of uncertainty, you want to wait for more data to come in to get a sense of how you want to act.”
Retail inflation at that time was 11.25 per cent and there was a consensus that there would be a rate hike. The RBI had paused instead.
“Inflation is set to rise, the environment for a rate cut effectiveness is very low and banks are not in a position to accommodate more transmission,” Niyogi said.
According to Gaurav Kapur of IndusInd Bank, the economy is going through a significant transition after demonetisation and the goods and services tax (GST). In addition, core inflation being sticky, cutting rates might not serve any immediate purpose.
However, other economists say if rates are not cut now, when inflation is so low, then no condition is ideal.
“With average retail inflation in 2017-18 set to remain significantly within the RBI’s comfort zone of 4 per cent, logic requires the repo rate be cut as the inflation targeting central bank changes policy rates with respect to the future trajectory of inflation,” said Soumya Kanti Ghosh, chief economist of SBI Group.
Pranjul Bhandari of HSBC wrote in a report that “India may have already become a 4 per cent inflation economy.” She expects a 25 basis points cut now and another one later this year.