RBI Likely to Ease MonPol Despite Risk of Inflation Target Failure

• Published on
• 06 Aug 2020, 12:37 PM

By Sophia Rodrigues

Economists are divided over whether the Reserve Bank of India will lower policy rates later Thursday, but the likelihood of cuts may be more than even.

Policy rates refer to both the repo rate and the reverse repo rate

The main argument against a cut is the high consumer price index inflation, with the latest data for June showing annual headline CPI rose 6.09% compared with a rise of 6.27% in May and 7.22% in April (both April and May inflation were calculated using imputation method).

With both March and June quarter inflation above 6% -- outside the RBI’s 2% to 6% target band – there is a worry that another quarter of high inflation (three straight quarters) would mean failure to meet the inflation target.

However, any failure to meet the inflation target in the current pandemic environment is unlikely to be the RBI’s major worry at this stage. All it has to do is explain to the government the reasons for failure to achieve the inflation target, the remedial actions it proposes and the estimate of the time-period within which the inflation target would be achieved.

In any case, high inflation outcome in the June quarter and persistence of high inflation in the September quarter is unlikely to surprise the RBI. In May, the RBI said headline inflation may remain firm in the first half of FY2020-21, and fall below target by Q3 and Q4 of FY2020-21.

Also, while some factors responsible for high inflation are beyond anyone’s control amid the pandemic, the RBI can still take comfort from outlook on food inflation after forecast of a normal southwest monsoon this year.

So even as the near-term inflation outlook looks more risky than in May, the RBI is likely to place more emphasis on prioritizing growth outlook.

The following two paragraphs in the RBI’s last statement is important:

“It is in the growth outlook that the MPC judged the risks to be gravest. The combined impact of demand compression and supply disruption will depress economic activity in the first half of the year.

Assuming that economic activity gets restored in a phased manner, especially in the second half of this year, and taking into consideration favourable base effects, it is expected that the combination of fiscal, monetary and administrative measures being currently undertaken would create conditions for a gradual revival in activity in the second half of 2020-21. Nonetheless, downside risks to this assessment are significant and contingent upon the containment of the pandemic and quick phasing out of social distancing/lockdowns.”

--Contact: Sophia@centralbankintel.com