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Rate cuts unlikely

N.S.Vageesh
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A poor monsoon will keep food prices high.
A poor monsoon will keep food prices high.

Another monetary policy review is around the corner — early this week. Repo rate, the key rate at which the Reserve Bank of India (RBI) lends money to banks, has been unchanged at 8 per cent for the last three months.

Predictably, as every policy announcement nears, there is a chorus of demands for policy rate cuts from banks and industries. There is, however, a gap between what is said for public consumption and what even banks and industry will admit to privately.

It is clear to everyone that there is nothing that has happened that warrants a rate cut now. While it is true that inflation as measured by the wholesale price index (WPI) did come down a shade at 7.25 per cent in June, compared with 7.55 per cent in May, it is still significantly higher than the threshold that the RBI finds comfortable.

The slightly lower than expected reading was due to lower primary articles and fuel prices. Given that a price revision is due in diesel, one can expect that inflation will once again rear up. The poor monsoon so far will also keep food prices high.

TRUANT MONSOON

The monsoon is still playing truant two months into the season. Large parts of the country, including Punjab, Haryana and other food grain-growing areas, have seen a rain deficit of between 50 and 70 per cent. This is certain to have a negative impact and cause food prices to shoot up once more.

Inflationary pressures are already being seen at the retail level — prices of the average households’ staple such as onions and potatoes are on the rise.

Supply-side constraints on food are not going to be addressed overnight. India survived the last failure in monsoon three years ago under entirely different conditions. That may have given the impression that the economy is ‘decoupled’ from monsoon failures. Certainly, the agri- economy is rain-fed and while agriculture’s share of the GDP may be going down, there’s no mistaking its criticality for overall growth.

The contingency plans that may have to be drawn up to tackle the possible failure of monsoons are going to cost money. If the governments, both at the Centre and State, are compelled to borrow more from the market in the months ahead, interest rates can only move up.

FUEL PRICE HIKE

A hike in diesel prices has been on the cards for some time now. The presidential elections are out of the way and the government has to bite the bullet — even at the risk of annoying allies. There is a fear that the move could trigger a pullout from the UPA by some of them, using it as the perfect pretext to hasten the next round of elections. But not effecting the hike now will only make matters worse in 2013, if it does manage to last the full term.

NO FISCAL CONSOLIDATION SIGNS

The RBI had, at the time of its policy review in April, cut its policy rate by a then-unexpected 50 bps — more in hope. The Governor had pointed out that it was for the Government to keep its part of the bargain and lay out a credible path of fiscal consolidation. That, in layman’s language, means raising fuel prices and doing something tangible about other subsidies and breaking the policy logjam. Four months later, that agenda is still pending.

Recent surveys indicate that investment spending by the corporate sector is likely to take a 15 per cent dip in this fiscal. That may well see this year’s GDP growth (pegged at 7.3 per cent) being revised further downwards. Although that may be cited as an argument for a rate cut, it is unlikely that a 25 bps cut will awaken the ‘animal spirits’ that the Prime Minister talked about. The economic situation is still weak in both Europe and the US.

The Governor will have to stay his hand.

(This article was published in the Business Line print edition dated July 30, 2012)
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