India’s Inflation may force RBI to stop further rate cuts, says IMF

IMF has cautioned that if inflationary pressure continues, there will be limited room for RBI to cut interest rates to support growth. “On monetary policy, given the sharper-than-expected slowdown and negative output gap (growth below potential), there is room to cut the policy rate further, especially if the economic slowdown continues. However, should inflationary pressures increase (stemming from the recent increase in food inflation and one-off prospective price increases in the auto and telecom sectors or resulting from fiscal pressures), the RBI will have limited room for further cuts”, the Fund said in its 2019 India Article IV Staff Report.

Earlier this month, the six-member Monetary Policy Committee of RBI surprised markets by deciding to hold the repo rate steady at 5.15 per cent, citing high inflation. The MPC, headed by Governor Shaktikanta Das, preferred to wait and watch for the previous rate cuts to trickle through before easing further.

But before that it had already cut 135 bps in rates of interest. “While the current spike in the headline inflation is arguably due to the temporary supply shocks on the food front, the impact is not confined only to a few items. It is important to understand how much would be the impact and for how long,” MPC member Ravindra Dholakia said.

Annual retail inflation increased to 5.54 per cent last month. RBI inflation target is 4 per cent. Retail food prices, that make up nearly half of India’s inflation basket, rose 10.01 per cent in November from a year earlier, against 7.89 per cent in October.

“There exists considerable uncertainty on the food price trajectory, and the quantum of impact of unseasonal rains on kharif output would be known only early next year. The incoming data may also provide greater clarity on the growth outlook,” deputy governor B P Kanungo said.

In the July-September period, India’s growth continued to slide, to a six-year low of 4.5 per cent.

GST tax cuts along with specific incentives for export oriented industries, particularly in the manufacturing sector, and strategic trade pacts have been prescribed by economists to end the phase of Stagflation which is currently plaguing the economy.

At present, economists have said that India is facing Stagflation − an economic trend marked by rising inflation and falling GDP growth.

As per the latest macro-economic indicators, subdued consumption trend, along with a massive contraction in manufacturing, agriculture and mining activities, pulled India’s GDP growth rate down to 4.5 per cent in the second quarter of 2019-20.

This is the slowest GDP growth rate in around six years. The growth on a year-on-year basis during Q2 2018-19 had risen to 7 per cent.

Economy watchers have blamed subdued demand, high taxation, low job creation, stagnant wages and stressed rural sector for creating the economic slowdown.  Already, sectors such as automobile, consumer durables and capital goods have come under heavy pressure due to the slowdown.  Furthermore, the slow growth rate along with the rise in retail inflation due to high food prices, especially those of vegetables and pulses, led to the phase of Stagflation.

Economist told IANS that measures such as direct and GST tax cuts and strategic trade pacts with the US and the UK will help in ending this economic phase.

“The reduction in the corporate tax rate is an important measure, but much more action is needed to augment private consumption and investment. There is not much fiscal space for spending at the Central level and the states too are constrained by lower tax devolution by the Centre due to low growth in central revenues,” M Govinda Rao, Chief Economic Advisor, Brickwork Ratings, told IANS.

“The most important action needed now is to fast-track the disinvestment and use the proceeds to augment capital spending. It is also desirable for the government to report the pending payments and off budget borrowings to show a realistic and transparent picture and then to provide a road map laying down the correction path,” Rao added.

Besides, the problem of credit and business confidence and overall financial stability needs to be looked at by the government, said Edelweiss Securities’ Economist Madhavi Arora.

“While there is a need for more dynamism in managing the NBFC stress, issues like elevated ‘term premia’ and ‘credit premia’ will continue to constrain long term funding, which remains the driving factor for economic activities and addition of new investment stock,” She said.

According to Acuite Ratings and Research’s Lead Economist Karan Mehrishi: “The revival of domestic demand is the key to offset Stagflationary pressures. The government needs to consider specific fiscal measures that can incentivise domestic consumption, given that the effectiveness of further monetary measures at this stage is limited.

Indo-Asian News Service