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Was the RBI Wrong in Holding Interest Rates?
Wed, 14 Jun Pre-Open

Just last week the Reserve Bank of India (RBI), held interest rates in its latest monetary policy review, citing an uncertain inflation outlook.

However, with macroeconomic data coming in, the same might not hold true for the months to come.

Data released by the Central Statistics Office showed the index of industrial production (IIP) slowed marginally to 3.1% in April from 3.8% a month ago as mining production and electricity generation eased. Retail price inflation, as measured by the consumer price index (CPI), slowed to 2.18% in May from 2.99% a month ago as food prices started falling from their year-ago level.

A lower inflation rate, coupled with slowing industrial activity. can indicate a slowdown in demand and weaker economic activity.

Slower industrial output growth and lower inflation may put pressure on the Reserve Bank of India (RBI) to change its policy stance to accommodative from neutral

The inflation number is also well in the range of the RBI's forecast for the current financial year, opening scope for a rate cut by the apex bank.

After the RBI decided to keep its key interest rates unchanged, chief economic adviser Arvind Subramanian publicly disagreed with the central bank, suggesting that softening inflation and slowing economic growth warranted a substantial monetary policy easing.

However, in its monetary policy review, RBI said the easing of inflation, excluding food and fuel, may be transient in view of its underlying stickiness in a situation of rising rural wage growth and strong consumption demand.

While the government is busy coining slogans and marketing them to lift the sentiments, RBI seems to have somewhat different opinion. And it intends to communicate it.

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As per the policy statement - The current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks. Monetary policy can play a more effective role only when these factors are in place.

Thus the RBI made it clear it would not adhere to the whims of the government, and take a myopic view just to fulfill the government's agenda.

But with industrial growth slowing down, and inflation at five-year lows, economic activity seems to be slowing down.

However, the RBI has a positive outlook going forward. The business expectations index generated by the RBI's April round of the Industrial Outlook Survey reflects optimism in the manufacturing sector in the second quarter of 2017-18, driven by expectations of rising rural demand, exports and profit margins.

Another catalyst, driving economic activity would be the onset of the monsoon. The Indian Meteorological Department (IMD) has forecast that the June-to-September south-west monsoon will bring 98% of the normal or long-period (50-year) average rain.

An early onset of the annual south-west monsoon and prospects of ample rain have led to higher-than-normal sowing of rain-fed kharif crops across India, according to data released by the agriculture ministry.

This could go a long way in spurring demand and growth in the rural areas.

On the manufacturing side, increased government expenditure and pick-up in private sector investment could provide the stimulus to the industrial sector.

It remains to be seen how the RBI takes into account the macroeconomic data coming in. If the economic activity fails to pick up over the next few months, an interest rate cut may well be on the cards.

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Feb 23, 2018 (Close)