Time to cut rates

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) will meet next Wednesday to review the central bank’s policy stance. The RBI has chosen largely to be cautious over the past months; it has not cut the policy rate since the first meeting presided over by Governor Urjit Patel last October. However, the minutes of the MPC’s last meeting suggest that the committee’s members are, in fact, more flexible than a straightforward reading of their actions since October would suggest. Certainly, the reasons why a rate cut might be possible – and, indeed, should be undertaken – have only strengthened since the MPC’s June meeting. Considering the benign inflation data and the continuing growth weakness afflicting the Indian economy, the MPC would do well to cut the headline policy rate at its forthcoming meeting.

Most startling and pertinent, of course, is the sharp drop in consumer price inflation. The consumer price index (CPI)-based inflation has gone down from 6.1 per cent in July 2016 to 1.54 per cent in June 2017. This would, ceteris paribus, suggest that tighter policy has worked; it might also suggest the RBI’s long-term aim of reducing the structural elements of inflation, including high expectations of future food prices, may have begun to be successful. It is worth noting that inflation is expected to continue below the RBI’s comfort zone of 2 per cent for at least another month. Meanwhile, growth has continued to slow. The January-to-March quarter of 2017 saw growth only at 6.1 per cent, which is the slowest rate in two years. There is also no sign of a recovery in private investment. To the extent that the RBI, now a formal inflation-targeting institution, still cares about pushing growth forward, this should be cause for serious concern — although, at the last MPC meeting, Governor Patel’s remarks suggested that the RBI’s medium-term view of growth was positive even without a rate cut.

It is true that some of the earlier considerations that had stayed the MPC’s hand when it comes to a rate cut are still in operation. There continues to be uncertainty about the effect of the goods and services tax, though it is no longer expected to be sharply inflationary in the short run. General government finances continue to need to be watched, with state deficits slated to rise given the power utility restructuring programme, Pay Commission awards and the pressure to waive farm loans. And, of course, worries about the strength of the global recovery as well as the actions of foreign central banks causing a sharp outflow of funds continue to be valid. But while in June it might have been reasonable to wait and watch, the confirmation since then of the sharp downward trend of inflation and growth means that the RBI can no longer sit on the fence. A rate cut is now clearly warranted. Furthermore, it should not be a token cut. The monetary policy transmission is flawed, as the governor has often noted; to be sure of having an impact, a cut of reasonable size should be considered.

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