Risks remain

The monetary policy committee, or MPC, of the Reserve Bank of India (RBI) will meet on April 5 and 6 for its bi-monthly review of monetary policy. After its last review meeting, on February 8, the MPC surprised markets by keeping the policy interest rates steady at 6.25 per cent, saying that it was awaiting clarity on the impact of demonetisation on India’s growth momentum and the inflation dynamics. The RBI is now formally an inflation-targeting central bank, following the signing of a memorandum of understanding with the government. Monetary policy is devised by the MPC to target an inflation rate of 4 per cent with a margin of 2 per cent. The last print of Indian consumer price index (CPI)-based inflation, for the month of February, was 3.65 per cent, year-on-year, up from 3.17 per cent in January. These numbers do suggest that the MPC was right in its last review to assume that there might be some underlying upside risk to inflation.

The question is if the underlying threat to inflation has moderated since February. A priori, there is no reason to suppose this is true — in fact, the reverse. After all, the demand slump caused by demonetisation had an effect on inflation in the November-February period. The slow remonetisation of the economy will naturally impact demand positively, which will feed into prices. Furthermore, “core” CPI-based inflation — which takes food and fuel out of the calculation, and is used to examine the persistence and expectations of price changes — was close to 5 per cent in February. Meanwhile, weather forecaster Skymet issued its first analysis of the 2017 monsoon this week, which suggested that rainfall might be below average this year. Further, it suggested that much rainfall would be front-loaded, followed by a comparatively dry spell. Thus the path of food inflation going forward is significantly more worrisome than it was in February.

Meanwhile, the slow recovery of the global economy has begun to tell in terms of the prices of crude oil and other commodities. India, as a net commodities and crude oil importer, is extremely sensitive to global price movements. While crude oil prices have actually fallen by almost 6 per cent since January 1, the Organization of Petroleum Exporting Countries might well extend its agreement to cut production. Recent analysis of shipments in March suggests that even countries not bound by the agreement, such as Nigeria and Libya, have begun to cut production. The future path of crude prices is thus unclear, as it depends on when the production cuts begin to impact overall oil shipments, as well as when a second wave of shale oil production from the United States hits the market.

Domestically, the recovery of demand after demonetisation might allow producers to finally seek to pass some costs on to consumers. Meanwhile, the effect of the goods and services tax on retail inflation is still uncertain. In other words, there are few, if any, markers to suggest that the situation has improved since February, while there are several indications that the upside risks to inflation have increased. Judging simply by these factors, it is hard to see any reason for the MPC to depart from its neutral stance in the February monetary policy.