India’s tryst with inflation targeting began four years ago when headline retail inflation was being dragged down from a scary double digit to 4%. As the first six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) met for the last time in its four-year cycle, inflation is back above its target.
Minus the novelty of the first meeting, the committee did what was expected this time too— voted unanimously to keep policy rates unchanged. From here on, rate cuts would get tougher with the old foe inflation coming back. Economists believe that the central bank can at best shell out another 50 basis points cut in the repo rate. That would bring the rate down to 3.50%, on par with the small savings interest rates of the country. A drop beyond this would be treacherous and hurt savers immensely. “Point of an accommodative stance is not to signal rate cuts. The odds of rate cut are low, if they were high the MPC would have voted for a cut today because it has been proactive so far,” said a debt fund manager.
Indeed, after chopping 115 basis points of the repo rate to 4% in under six months, Governor Shaktikanta Das perhaps has reached the end of the rate cut road. At least bond markets seem to think so. Bond yields rose marginally across tenures today after the pause on rates. The policy statement too indicated that future rates will depend on how inflation behaves. As such, FY21 would witness a recession and the central bank has done all it can to mitigate risks. “While space for further monetary policy action is available, it is important to use it judiciously to maximise the beneficial effects for underlying economic activity,” the statement said.
So how will retail inflation behave?
The MPC believes that inflation may remain elevated until September and then ease off due to a combination of base effect, softer food inflation and further smoothening of supply side disruptions. Food inflation has historically been volatile and the pandemic induced supply disruptions have meant that perishables are hard hit. Inflation over the past two months has been driven mainly from vegetables and fruits. But food is perhaps the only segment that promises to ease. “Looking at past trends of seasonality, the rise in vegetable prices in July could fade in September. Alongside this, a favourable base is expected to push inflation below the 4% target in 4Q2020,” wrote Pranjul Bhandari, chief economist at HSBC Securities and Capital Markets (India) Pvt Ltd in a note. Fuel inflation has been due to increase in taxes and since they won’t be rolled back anytime soon, the pressure is here to stay. That leaves core inflation. Here, the outlook is unclear but early indicators show that prices are unlikely to ease off in a big way.
But the RBI’s professional forecasters’ survey shows that inflation is likely to ease to below 4% by end of FY21 but due to statistical base effect. In short, there may be space for further rate cuts but the odds are dim right now.