Five concerns raised by Rajan

Reserve Bank of India governor, Raghuram Rajan at the end of his policy speech said he was pleased that the market was getting a hang of what the central bank was doing. To get an idea of how predictable RBI’s policy has become, consider the fact the all 53 analysts surveyed by Reuters expected the central bank to keep the repo rate unchanged. Rajan met their expectation by keeping the repo rate at 8 per cent even though he had some breathing space by way of low inflation.

The fact that all 53 analysts got their prediction right (probably the first time ever), is because it was a no-brainer. Elections are just round the corner, and playing around with interest rates would have little impact on the economy which is now in a pause mode, especially in the manufacturing sector. Further, chances are that monsoon could be erratic, and could affect crop production and fuel inflation. There was little point in changing interest rates with two main events expected to unfold in the coming quarter.

Corporates would not have gone on investing had RBI reduced rates given the uncertainty overhang.

In any case, RBI expects growth to pick up only marginally, that too if inflation remains under control. Rajan in his policy speech said that GDP growth is projected to pick up from a little below 5 per cent in 2013-14 to 5-6 per cent in 2014-15, with a downside risk to the central estimate of 5.5 per cent. Lead indicators have not yet pointed to any sustained revival in industry or services.

Though RBI has signalled no changes in policy rates, the underlying message of the governor’s speech is that of caution. Following are five concerns raised by the central bank:

Global activity has moderated since January 2014, with continuing sluggishness in Euro and subdued pick-up in emerging and developing economies. For a number of emerging markets, further tightening of external financing conditions and renewed volatility of capital flows are the biggest risks to their outlook.
On the Indian economy, RBI says that in the quarters ahead, the boost provided by agricultural production in 2013 may wane. Moreover, the outlook for the 2014 south-west monsoon appears uncertain.
Retail inflation measured by the consumer price index (CPI) moderated for the third month in succession since February 2014, mainly on account of a sharp fall in food prices. However, prices of fruits, milk and products have started to firm up. Excluding food and fuel, retail inflation has remained sticky, indicating demand pressures are still at play. This sticky inflation can be a dampener for those hoping that central bank will reduce interest rates going forward.
Sluggishness in industrial activity, exports and several categories of services underlines the need to revitalise productivity and competitiveness.
Recently, export growth has slowed because of slowdown in demand in partner countries as well as softening of prices of exports of petroleum products and gems and jewellery (thanks mainly to curbs on gold imports).