The decision by the Reserve Bank of India (RBI) to not raise rates on October 5 took the market completely off-guard. The market consensus (including mine) was a rate hike by the RBI
in consonance with a weakening rupee
and the threat of Brent touching the magical three-figure mark. The rupee
recovered strongly on Friday, with oil, the US treasury rates all retreating from their highs. In hindsight, it seems the RBI
decision to hold rates against the overwhelming market consensus was justified. It also seems crude oil
prices will prove lucky for the RBI.
Consider this. During 1994-95, the WPI inflation
(the inflation target at that time) had increased from 7.5 per cent in April 1994 to a whopping 16.9 per cent in March 1995. In response, the RBI hiked the CRR (repo rate
was not a policy instrument then) over three consecutive months (June-August) by a cumulative 100 bps. Even after that, WPI continued to rise and reached a peak in March 1995, indicating monetary tightening was yet to play out decisively. Brent oil
came to the rescue and prices declined by 14 per cent from its peak, pulling down the WPI to 6.6 per cent by end-1995.
Fast forward to 2013-14. The CPI inflation increased from 8.5 per cent in April 2013 to 11.5 per cent in November 2013. Meanwhile, RBI increased the repo rate
in three tranches — by 25 bps each — over September and October 2013 and January 2014. The increase in repo rate
did have an effect on consumption, but only when crude prices started to crash and declined by around 30 per cent from its peak during this period. The CPI started decelerating rapidly and reached 3.3 per cent in November 2014. Crude was the saviour again.
Will the current decline in oil
prices be lucky for the RBI? We believe the decline in oil prices will continue. An analysis of global growth projections by the IMF in its World Economic Outlook (WEO; April and October issues) tells us a different story. Our analysis suggest that since 2012, oil prices in the first half are always greater than or equal to the second half of a year. The reason is that IMF in its WEO report always projects a better picture at the beginning, only to revise it later. Hence the recent firming of oil prices may be subdued in the second half of the year and will not pose a big risk of inflation. Further, the demand of oil increases in H1 due to an increase in tourist activity in Europe, which subsequently increases the demand for aviation fuel. With the IMF revising its global growth projections downwards, there is every reason to be optimistic. The US recovery in terms of the number of months is pretty close to the historical peak of 120 months. So by all historical evidence, we might be looking at global growth slowdown in the future and oil could be the barometer.
Meanwhile, the decline oil prices will help the CPI inflation to remain below 4 per cent for the next couple of months. The immediate concern is continued and significant deceleration in food prices particularly in rural areas. The MSP pass-through is negligible. The government needs to ensure the procurement plan is implemented aggressively ahead of the kharif season.
Finally, for those who are baffled by the RBI not hiking rates, I offer two responses. One, a 2018 study (Michael Patra et al) by the RBI notes that the degree of exchange rate pass-through in the Indian economy has declined in the post-2014 period than in the years prior to it. This expands the degree of freedom for the policy maker to pursue an independent monetary policy. Two, to quote from an RBI governor’s speech, “while financial stability considerations are not explicitly in the RBI’s objectives, they make their way in because the RBI has to keep growth in mind while controlling inflation”.
The author is group chief economic advisor, State Bank of India. Views are personal