June 17 - the next date for RBI's monetary policy is one of the most awaited economic events. Given that the economic growth has slowed down and the wholesale price inflation (WPI) has eased, one may expect the central bank to cut rates in the next monetary policy review. However, the central bank has some more factors to consider this quarter. Unfortunately, not all might support a rate cut.
The central bank's decision on interest rates is primarily based on the growth- inflation dynamics. This time, monsoons will play an important role in shaping up the monetary policy. As we all know, while WPI has eased, the consumer price inflation (CPI) still remains high. Given that food forms a considerable part of the consumption basket, food prices are likely to influence central bank's action on rates. And that, in turn will be shaped up by the monsoons. A good monsoon can help in easing food inflation, thus tilting odds in favor of rate cut. However, given the vagaries of Indian monsoons, it will not be too wise to count on that.
There are further reasons why the RBI may hesitate to ease the rates. The most important of them is the problem of twin deficit. As the rupee is setting new lows against the dollar, imports are going to be costlier and inflation levels higher. The attempt by the Government to raise fuel prices will be nullified by the falling rupee and increased losses on fuel import and fuel subsidies. With the US set to lower the pace of quantitative easing, it is quite likely that rupee will remain weak, thus limiting the chance of monetary easing.
Hence those expecting rate cut in the next monetary policy review may get disappointed. However, we believe that it is unfair to expect monetary policy to make much difference to the growth in the economy. A long term sustainable growth needs structural and regulatory reforms and that needs to be the focus of the government.