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Does RBI Governor Urjit Patel really have a case to cut interest rates?

26 September, 2016

Is the Reserve Bank of India (RBI) finally set to cut interest rates?

Newspaper reports on Monday said that the new central bank governor Urjit Patel has ‘downplayed’ the risk of inflation, and wants to focus on growth. 

Now, unlike his former boss Raghuram Rajan, Patel is a reticent man, and does not talk to the press. He did, however, meet a select group of economists, behind closed doors and, say reports, hinted at a rate cut in December. 

The RBI will, likely give the rate cut a pass on 4 October when it meets to discuss its monetary policy, but will maintain a ‘dovish and accommodative’ stance on interest rates, The Economic Times said. 

Patel is arguably under a lot of pressure to cut interest rates, especially considering the fact that Rajan quit following a controversy that stemmed from his hawkish stance on inflation, owing to which he held steadfastly to his stance of not lowering the interest rate. 

But does he really have a case for lowering interest rates? Is inflation really no longer a worry? For that, we will have to clinically dissect the numbers.

If one takes a slightly long term scenario, inflation has indeed eased. Sajjid Z Chinoy, chief India economist at JPMorgan, noted in an article published Mint newspaper last week how between 2007 and 2013, average consumer price index (CPI) inflation was 9.5%, but in the last 30 months, it had averaged 6%, despite the fact that two of the last three years have seen drought-like conditions.

And this year, we have had a good monsoon, with the rains at near normal levels. This will mean better sowing as compared to the last two years, and consequently, better yields. This, in turn, should ease supply-side constraints, and lead to lowering of food prices, that have been a major reason for hardening consumer prices. 

In fact, India’s August CPI inflation was at a five-month low of 5.05%, with food inflation at 5.91%, down from 8.35% in July—industrial growth for July contracted 2.4%.

So, prima facie, Patel might just have a case to cut interest rates in December, while advocating a focus on growth. But, like in any scenario, there’s a flip side. 

Although CPI inflation may have eased, it remains above the government’s target of 5% by March 2017. In fact, July’s figure was 6.07%, well ahead of the 6% upper tolerance limit that both the government and the RBI have agreed on. 

Moreover, at 6.5%, the repo rate is already at its lowest since 2011. 

Moreover, in what might add to inflation, oil prices have begun inching upwards on hopes that the Organisation of Petroleum Exporting Countries (OPEC) could reach a deal this week to limit crude production and help support prices following a glut that has kept them low for a better part of the last two years, especially following Iran’s return to the international market after its nuclear deal with world powers. 

Even as we crystal gaze, there is one last factor that we must consider. For the first time, a six member monetary policy committee will take a call on interest rates from now on, with the RBI governor having a casting vote. This effectively dilutes the governor’s influence, except in the case of an unlikely tie.

Raghuram Rajan held his ground, but will Urjit Patel cede?

Your guess is as good as mine.

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Does RBI Governor Urjit Patel really have a case to cut interest rates?

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