The writing on the wall
In June, the Reserve Bank of India (RBI) cut rates but the guidance was perceived as hawkish and markets were unhappy. On Tuesday, RBI stayed on hold but opened the door to potential easing down the road, but markets again remained unimpressed. What this suggests is the problem isn't about communication. Instead, there is a more fundamental gulf between what policymakers believe is possible on rates and what market participants would like to think is possible.
In the short run, the disconnect may be contained. Can there be another rate cut this year? Yes, indeed. We have global benevolence to thank. Over the past three months, oil prices fell 30 per cent, commodities another 15 per cent, and the monsoon has progressed better than expected, although forecasts for August and September are less than rosy, suggesting a growing risk that inflation will undershoot the RBI’s projected path, opening up space for one more rate cut, possibly as early as September 29. Separately, the fact that India is contemplating rate cuts, at a time when the US Fed is preparing to hike, is itself a testimony to India’s macroeconomic adjustment since 2013.
What markets have to begin to accept is that there is no space for a large easing cycle. Forget about the four per cent inflation target, for a moment. Let’s assume the RBI only wants to endeavour to keep inflation below six per cent, since the band permits inflation to be between two-six per cent. Is that a fait accompli? Absolutely not. At a time when growth remains very weak, and India is reaping the benefit of a 40 per cent disinflation in crude prices, a 20 per cent disinflation in global commodities and food prices, inflation is still averaging about five per cent over the past three months. That, in itself, suggest the stubbornness of underlying inflationary pressures. So, when growth and pricing power were to eventually recover, and India does not benefit from such large global commodity disinflation, will inflation in India easily sustain below six per cent in the coming years? It’s not clear it will.
This implies two things. First, the RBI does not have much, if any, space to cut rates. Second, more important, it’s critical the government keep working to boost the supply side – land, power, coal, labour, food production and distribution – to lift the non-inflationary rate of growth in India. These are complex and difficult asks. So, the faster the market appreciates the ambitiousness and necessity of what’s being undertaken and the complexity that it entails, the less (hopefully) will be the boom-bust nature of expectations that surround each policy review.