No room for repo rate cut even after sharp drop in inflation, economists say

No room for repo rate cut even after sharp drop in inflation, economists say

The sharp easing of inflation to 14-month low would not create space for lowering of short term policy rate by the inflation targeting central bank, economists said. The Reserve Bank of India’s action would rather be shifted to calibrated liquidity normalization, they observed.

Inflation measured by the Consumer Price Index (CPI) eased to 4.59% in December, more than what the market expected, compared with 6.93% in November. Core inflation, which does not factor in food and oil prices softened to 5.2% against 5.4% earlier.

Headline inflation is expected to stay within the target band over the next few months, albeit price undercurrents by way of commodities, taxation rigidity, rise in manufacturing costs and demand impulses in certain core categories will keep the central bank from lowering rates further, DBS Bank economist Radhika Rao believes.

“With much of the policy fine-tuning kept to the liquidity space, we expect the RBI to keep rates on hold this year,” she said.

RBI has kept the short term repo rate — the rate at which the banks borrow from the central bank against government securities — unchanged at 4% in the last three policy meetings. Reverse repo rate now stands at 3.35%.

“View on the repo rate is set to diverge from the liquidity stance as cyclical recovery gains traction. The recent resumption of normal liquidity operations, along with the lapse of the CRR relaxation by end of March will be a soft-tap on the liquidity brakes. The next policy move might be to gradually narrow the wide repo-reverse repo corridor,” she added.

January inflation is likely to ease further factoring in fading pressure in food and favourable base effects, experts believe. The headline index may edge up to over 5% by March when the impact of base effect subsides and, according to HSBC’s chief India economist Pranjul Bhandari.

The latest CPI inflation print however would comfort the Monetary Policy Committee (MPC), which is expected to lower its inflation forecast for Q4FY21 meaningfully by 70-80 basis points amid current food price momentum, versus the RBI’s own projection of 5.8%, Emkay Global Financial Services said.

The Nomura RBI Policy Signal Index signals that MPC will remain accommodative at its policy meeting on February 5, due to still-negative growth and lower headline inflation. “We believe that the shelf-life of ultra-accommodative monetary policy is fast expiring, and the debate has shifted to how to taper without disruption. With headline inflation low, but underlying price pressures building, we expect the RBI’s liquidity policy (gradual normalization) to differ from its rates policy (unchanged) this year,” Nomura said.

Economists at the CARE Ratings and the India Ratings & Research agreed.

“Core inflation is still high. MPC will keep a close eye on the forthcoming budget to ascertain the government’s fiscal stance,” India Rating’s chief economist Devendra Kumar Pant said.

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