The Monetary Policy Committee’s unanimous decision to opt for a pause in policy rate cuts does not sit comfortably either with its stated reasons for higher retail inflation or its own admission that economic activity has further weakened.
The retail inflation of 4.6 per cent in October was largely due to increase in food prices, which is seasonal, and more transient in nature. But fuel group prices have been in deflation for four months in a row. And core CPI inflation (excluding food and fuel groups), actually dropped in October compared with September.
On the growth front, things have only worsened. Manufacturing has seen a 1 per cent contraction in the second quarter after almost a flat first quarter.
This is clearly reflected in capacity utilisation of the industry that has dropped to 68.9 per cent in July-September compared with 73.6 per cent in April-June this year. The output in eight core industries — which make up 40 per cent of the index of industrial production — too contracted for the second consecutive month in October.
So, if RBI is aware that high retail inflation is only fleeting and there is no upside to growth, why would it not cut rates?
It is probably exercising caution, given the likelihood of rising inflation over the next two months and the two unknowns: the quantum of breach in fiscal deficit this year, and the expenditure stance of the government in the Budget for 2020-21 to be announced in February.
Retail inflation is expected to rise further to 5.5 per cent and then to probably 6 per cent in December, driven largely by food prices. RBI’s own surveys suggest inflationary expectations over the next three months have risen 120 basis points.
How does a rate cut sound when inflation is much higher than 4 per cent, its single-point mandate as specified in its monetary policy framework agreement with the government? Besides, given the growth numbers, RBI may also expect the Budget in 2020-21 to be fiscally expansionary, and hence prepare in advance.
In doing so, however, the RBI is not looking at a longer one-year retail inflation trajectory. In another 6-12 months, CPI inflation is expected to moderate to 3.8 per cent to 4 per cent. Further, it has chosen to ignore core inflation (excluding fuel and food prices), and focus exclusively on CPI inflation.