Abundant caution and a prudential approach mark the Sixth Bi-Monthly Policy Statement of the RBI issued yesterday. Conditions are favourable for some relaxation in policy rates. Marking the fifth consecutive month of softening retail inflation measured by consumer price index turned down sharper than expected in December and reached its lowest reading since November 2014. The outcome was driven by deflation in the prices of vegetables and fruits.

Some moderation in the rate of increase of protein-rich items — eggs, meat and fish — also contributed to the downtrend in food inflation. Excluding food and fuel, inflation has been unyielding at 4.9 per cent since September 2016.

The Central Statistics Office has released an advance estimate for the country’s real gross value added (GVA) growth at 7 per cent for 2016-17 although it is revised downwards from the first revised estimate of 7.8 per cent.

Mixed outlook

Agriculture and allied activities posted strong pick-up due to the normal south-west monsoon, robust expansion in rabi sowings (higher by 5.7 per cent over the preceding year). The industrial sector experienced a deceleration mainly due to a slowdown in manufacturing and mining and quarrying. Service sector also lost pace concentrated in trade, hotels, transport and communication services and construction cushioned to some extent by public administration and defence.

The developments in the external sector are favourable. Export growth was positive for the fourth month in succession in December. Imports other than petroleum and lubricants (POL) came out of the spike in November and moderated in December. However there was an increase of over 10 per cent in oil imports partly reflecting the rise in crude oil prices. This rise is one of the reasons for the cautious policy adopted by the RBI. High frequency indicators point to subdued activity in the services sector, particularly automobile sales across all segments domestic air cargo, railway freight traffic and cement production. Nevertheless, some areas stand out bright having weathered the transient effect of demonetisation — steel consumption, port traffic, international air freight, foreign tourist arrivals, tractor sales and cellular telephone subscribers.

Onus on Budget

However, a caveat has to be entered. The central bank’s industrial outlook survey suggests that financing conditions facing the manufacturing sector have worsened in the third quarter of 2016-17 and are expected to remain so in the next quarter.

This is enigmatic. The large overhang of liquidity consequent upon demonetisation weighed in money markets in December but from mid-January rebalancing has been underway with expansion of currency in circulation and new bank notes being injected into the system at an accelerated pace.

With deposits growing faster than credit there is surplus liquidity in the system. The abundance of liquidity and market conditions make it irrational to reduce the policy rates.

Monetary policy has a longer time horizon than the immediate future. In US the policy takes into account the likely developments a year ahead. The RBI has highlighted three significant upside risks that impart some uncertainty: the baseline inflation path-the hardening profile of international crude oil prices, volatility in the exchange rate on account of global financial market developments that could impart upside pressures to domestic inflation and fuller effects of house rent allowances under the 7th Pay Commission award, which have not been factored in the baseline inflation path.

The absence of effective demand from consumers in the market is due to the high level of prices. Mere stability in the inflation rate is not enough to stimulate demand. Government and the industry should formulate measures to reduce the cost of production of goods and services. Construction is one area that can have multiplier effect on a number of industries – steel, cement, etc., besides producing a favourable effect on employment. But today the common man is priced out of the market and liberal financing of home loans would only add to the problem of non-performing assets. The emphasis in the Union Budget for 2017-18 on stepping up capital expenditure and boosting the rural economy and affordable housing should contribute to growth.

The writer is a Mumbai-based economic consultant

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