If ever there was a compelling case for RBI to cut rates, it is today with CPI and WPI month on month inflation below 5 per cent for last six months.
The economists have a consensus — there will be no rate cut today. The question remains: How much of this forecast is based on herd mentality, and how much is based on data that the RBI must consider before making interest rate policy?
The most important variable determining the present RBI stance on interest rates is inflation as measured by the consumer price index (CPI). In its last policy statement (in June), Governor Raghuram Rajan stated: “If disinflation, adjusting for base effect, is faster than currently anticipated, it will provide headroom for an easing of the policy stance.” Translated into English, what the doctor said was that if there is a decline in the rate of inflation, and this decline is not due to seasonal factors and not due to abnormally low inflation in a comparison month last year (base effect), then the RBI will have a valid basis (headroom) for an easing of monetary policy.
Regarding the base effect. Last year, year-on-year CPI inflation March through June was 9.1 per cent, a value lower than the first six months average of 9.6 per cent (y-o-y figures not reported in table). Thus, the base effect goes the other way, that is, if inflation in 2014 is lower, it is because of structural factors and not due to seasonal biases.
The seasonal effect of inflation is best examined by the use of seasonal factors, a science considerably well developed in the West. Most policymakers in the world use seasonal factors in order to determine the course of structural variables like output and prices. For some unknown reason, the RBI has been allergic to the use of seasonal factors, though every sabziwallah, and therefore everybody, knows about the importance of seasonality in food prices. Indeed, that might be one important reason why monetary policy in India has not exactly been path-breaking. Given the new modern regime in Mumbai, it is hoped that sooner rather than later, seasonally adjusted data will be a standard feature of data dissemination and policy discussion.
The table reports month-on-month calculations on various inflation indices for the first six months of 2014 and the corresponding months in the preceding three years. For the CPI and the wholesale price index (WPI), only the rates of growth for non-seasonally adjusted data are reported; this is done to make the analysis continued…