Holding rates of interest: RBI cites inflation which raises questions

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.

Written by P Vaidyanathan Iyer

New Delhi | Updated: December 7, 2019 08:30 AM IST

3 min read

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.

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.

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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.

Also read | Despite RBI’s temporary pause, borrowing cost may still fall as spread narrows

P Vaidyanathan Iyer

P. Vaidyanathan Iyer is The Indian Express’s Managing Editor, and leads the newspaper’s reporting across the country. He writes on India’s political economy, and works closely with reporters exploring investigation in subjects where business and politics intersect. He was earlier the Resident Editor in Mumbai driving Maharashtra’s political and government coverage. He joined the newspaper in April 2008 as its National Business Editor in Delhi, reporting and leading the economy and policy coverage. He has won several accolades including the Ramnath Goenka Excellence in Journalism Award twice, the KC Kulish Award of Merit, and the Prem Bhatia Award for Political Reporting and Analysis. A member of the Pulitzer-winning International Consortium of Investigative Journalists (ICIJ), Vaidyanathan worked on several projects investigating offshore tax havens. He co-authored Panama Papers: The Untold India Story of the Trailblazing Offshore Investigation, published by Penguin. ... Read More

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