THE SUSTAINED fall in retail inflation — especially the 1.2 per cent in food prices last month — may pave the way for a rate cut by at least 25 basis points when the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) meets on August 2. However, the MPC decision is unlikely to be unanimous and the tone of the policy document may not signal that further cuts would be forthcoming, analysts and bankers said. Paving the way for a rate cut, Consumer Price Index inflation eased below the 2 per cent floor of the target band in June, which is a reasonably favourable progression of the monsoon and kharif-sowing so far and limited evidence of a sharp spike in prices following the introduction of Goods and Services Tax.
“There is a strong likelihood that the MPC would vote to reduce the repo rate by 25 bps in August first week. The industry and government are anticipating a rate cut this time,” said the top official of a nationalised bank. “The expected rise in CPI inflation in H2 FY 2018 is likely to contribute to a lack of consensus in this vote to cut the repo rate, and infuse caution in the tone of the policy document regarding the possibility of future rate cuts,” said Naresh Takkar, managing director and group CEO, ICRA.
The 10-year benchmark government securities (G-Sec) yield has fallen by around 25 bps since the beginning of FY 2018 to 6.42 per cent, which has partly raised the likelihood of a rate cut by the MPC next week. Loan growth remained subdued at 6.3 per cent on a year-on-year (YoY) basis at the end of first quarter of FY 2018 and the Index for Industrial Production is down to 1.54 per cent in June from 2.18 per cent in the previous month.
“Given that inflation reading has further surprised with sub-2 per cent print (well below the RBI’s own estimates), we find some room for RBI to be accommodative. We expect the MPC to cut repo rate by 25 bps at the August meeting,” Kotak Securities said in a report. “But we reckon that the room for further monetary accommodation remains limited amid mean reversion of food prices, rising real rural wages, onset of global financial tightening and adverse base effect,” it said.
IDFC Bank chief economist Indranil Pan said, “With CPI inflation now expected to average at 3 per cent for FY18 — significantly lower than RBI’s target of 4 per cent — there is a realistic chance building up for a 25 bps repo rate reduction in August.” On the flip side, the RBI is expected to remain cautious of international rhetoric on tighter monetary policy, QE unwind, etc. “The August policy could be the last chance for RBI to reduce repo rate,” Pan said.
In the June policy, while five in the six-member MPC, voted in favour of keeping the Repo rate steady at 6.25 per cent, Ravindra H Dholakia was against the majority proposal.
“The current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks. Monetary policy can play a more effective role only when these factors are in place. Accordingly, the MPC decided to keep the policy rate unchanged with a neutral stance and remain watchful of incoming data,” the MPC said.
Dholakia argued for a minimum interest rate cut of 50 basis points citing “the prevailing inflation and output conditions and prospects” that provided enough space to act decisively to back growth. Any failure to cut the policy rate would amount to “ignoring all costs associated with not supporting growth in terms of unemployment and poverty reduction,” the minutes of the June 6-7 meeting, released on June 21, said.
The central bank risked losing the opportunity provided by the favourable conditions of a “clear declining trend rather than stickiness” in core inflation, Dholakia had argued.
Headline CPI inflation fell to 1.5 per cent in June from 2.2 per cent in May, led by food inflation at -1.2 per cent in June as against -0.2 per cent in May. However, food inflation is likely to rise from August as the base reverses.
Even as core inflation witnessed a dip by 40 bps in June to 3.8 per cent, this might not be durable with the higher HRA allowances under 7th Pay Commission to be factored in from July. Cumulative impact of the allowances on CPI inflation is likely to be at 40-50 bps.
Will the RBI give more weightage to this factor?
Analysts said the dip in food inflation is attributable to further decline in vegetables and pulses. Prices of vegetables fell by 16.5 per cent on a YoY basis compared with the 13.4 per cent decline seen in May. Pulses prices fell by 21.9 per cent in June against the 19.5 per cent decline seen in May.
As base effect wears off from August onwards, food inflation is expected to move higher. On the other hand, with monsoon expected to be normal this year, food inflation is likely to continue to stay relatively benign this year, they said.