Consumer price inflation at 1.5 per cent in June is once again below the RBI’s desired level. With retail inflation hitting the skids, rate cut expectations are at a feverish pitch with the government pontificating about the RBI’s ‘error prone inflation forecast model’.
Proceedings of the Monetary Policy Committee (MPC), which meets on August 2, will be closely watched, as the six-member MPC deliberates whether the below-target inflation is a temporary blip and how low can it fall. This will be Governor Urjit Patel’s most defining moment yet. He could shrug off the record-low inflation as a little bad data and stay committed to his hawkish stance asserting RBI’s independence, or bite the bullet with a marginal cut. No matter what, it will go down in history.
According to the Bank of England, central banks rarely have interest rates more than 3 per cent above inflation. If inflation is at 2 per cent, it is unlikely rates will be much more than 5 per cent. By this logic, rate cut demands seem reasonable. But should the RBI revise rates if inflation shoots up in July or August leading to an unstable policy rate environment? Monetary policy is based on judgments about what inflation might be—the outlook over the coming few years—not what it is today. Patience is key as it affects with a time lag. Right now, headline inflation is going only one way—downwards. Investors expect the rates to follow downhill to revive investments.
Despite surplus funds, credit growth stopped in its tracks, because companies are over-leveraged with risk concentrated in sectors that matter the most—steel, infrastructure, power and telecom. The question to ask is if monetary policy alone can correct the slack in corporate spending. The RBI’s rate-cutting cycle began in 2015 and the policy rate is already sliced to the bone, yet the promised private investment didn’t happen. The dominant demand to cut 25-50 bps will help companies sponsor a corporate luncheon at best, hardly the much-needed economic rocket booster.