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With inflation at 5-year low, RBI must end its obsession


CPI and WPI food inflation have softened to 7.6 percent and 3.5 percent respectively

While there has been little doubt that inflation-hawk Raghuram Rajan has been unmindful of the growth imperatives, the question now is whether the RBI ignores even the low inflation numbers.

After the latest data showed consumer price index-based retail inflation at 6-year low of 6.5 per cent for September, the wholesale price index-based headline inflation at 5-year low of 2.38 percent. What's important, CPI and WPI food inflation have softened to 7.6 percent and 3.5 percent respectively. The manufactured prices as measured in terms of core inflation for CPI and WPI are as low as 5.9 percent and 2.8 percent, respectively, reflecting loss of pricing power of manufacturers and a general slump in the economy.

The weak growth momentum and the negative output gap (the difference between actual and potential GDP growth) helped pull inflation lower. Low levels of demand as reflected in sub-optimal capacity utilisation have diminished pricing power of Indian corporates especially SMEs. Doesn't it warrant a cut in interest rates now?   

There still seems to be a difference in opinion in the country. While a section in government appears dejected at RBI's inert behaviour towards growth imperatives, the so-called market-oriented economists still believe RBI will not touch rates in this year even if the upside risks have subsided significantly given the softening of global crude and commodity prices, stable rupee, continued supply-side efforts to contain food inflation.

The CPI inflation for September reinforces the view that the RBI's January 2015 CPI target of 8 percent will be easily met. Still, economists at foreign banks say an early rate cut may be wishful thinking for two reasons: inflation expectations remain elevated and the January 2016 CPI target of 6 percent is also becoming prominent on the RBI's radar –- this target is more ambitious particularly considering historical attainments.

Even if RBI turns a deaf ear to inflation and growth numbers, other key parameters are pointing to the need for a lower interest rate regime -- credit off-take and loan-deposit ratios are declining, indicating that money market rates are set to fall. Also, easing of inflation has helped in a fall in the real effective exchange rate (REER). 

The downward trend in inflation is a clear reflection of an overall dampening effect of economic slowdown on aggregate demand. Some of the glaring evidence of this can be seen from the industrial growth for August that printed at a measly 0.4 percent, the lowest in 12 months. Car sales, a gauge for consumer demand, were down 1 percent in September after growing for the previous four months. Given the present dismal situation, the dampened demand for industrial goods may keep the GDP growth in second quarter well below the 5.7 percent recorded in April-June.

Instead of aiding in the recovery, RBI's unmindful tight monetary policy may push the economy further to a lower growth trajectory. It's time, the government take up the task of reforming of monetary policy by setting up a panel of official from government and RBI to determine rates rather than leave the crucial policy at the whims and wishes of a few individuals at the RBI. If RBI has been set up by an Act of Parliament, the central bank governor should ideally be made accountable to Parliament for its decision on rates just as it is the case with US Federal Reserve.

(R K Ray can be reached at raj@skoch.in)

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