If inflation is falling, why is RBI not cutting rate

If inflation is falling, why is RBI not cutting rate

Interest rate cuts have been a point of dissension between RBI and the government for some time now. With the economic growth still patchy, corporate earnings muted and retail inflation at a record low in July, the government has indicated that RBI must go ahead and cut interest rates to accelerate growth. Raghuram Rajan has been cautious in this regard. Notwithstanding a sharp fall in retail and wholesale inflation in July, the central bank governor said controlling inflation is a “work in progress” area for the RBI. With the next monetary policy announcement scheduled on September 29, we tell you why is RBI is not cutting rates rapidly. 

 

Select food prices up: While official data states that retail inflation— the price level of goods and services purchased by the final consumer—fell to multi-year low of 3.78% in July, the on the ground situation seems to be different. This is because prices of two important food items—onions and pulses, have shot up drastically. The price of onions, a staple vegetable in Indian households, is up at a two year-high. The price has risen more than 50% in many Indian cities. Prices of protein-rich pulses are also inching up to a two-year high, an Assocham report stated. 

 

Monsoon worries: After a better-than-expected rainfall in June, rains seem to be playing truant in the consecutive months. While June received excess rainfall, July witnessed deficient rainfall of 17%. August too is expected to bring in a 10% deficiency in rainfall, according to MeT department. On the back of this data, RBI, in its Annual Report for 2014-15 stated that “uncertainty surrounding the progress and distribution of the monsoon remains a risk to the outlook for both growth and inflation”. The central bank also suggested comprehensive food management techniques to be put in place to tackle dry spells. 

 

Convincing slide in inflation a must: At a recent banking event, Raghuram Rajan noted rather categorically that interest rate cuts must not be “goodies that the RBI gives out stingily after much public pleading”. He also added that RBI has to build credibility among the aam aadmi that it will act firmly against future price rises. For this purpose, a sustained period of low inflation is important. Furthermore, consistent low inflation will help lower the public’s inflationary expectations and also increase their real disposable income. This, according to Rajan, will be a victory against the inflation demon. 

 

Poor transmission of rates by banks: Criticizing banks for not passing on the benefit of rate cuts to the common man, RBI ‘s Annual report noted a difference between its policy and banks’ lending rates. “the willingness of banks to cut base rates – whereby they forego income on existing borrowers in order to attract more new business -is muted”, the report said. The RBI has reduced repo rate by 0.75% since January. A further cut in rate may well prove to be futile if banks do not pass transmit this change to the final consumer.

Happy Investing

Source:Reuters