Urjit Patel vs rate-cut

lobby: A psychological
game is on the cards,
not just data crunching
Urjit Patel and his fellow members in the Monetary Policy
Committee (MPC) may be having sleepless nights ahead of
the bi-monthly monetary policy review slated for
Wednesday (2 August). There is immense pressure both
from the industry and the government to go for a quarter
percentage point rate cut, if not 50 bps (basis points), on
Wednesday. One bps is one hundredth of a percentage
point.
A direct pitch for a rate cut came from chief economic
advisor to the government, Arvind Subramanian, earlier
this month after the Consumer Price Index (CPI) slowed to
1.54 percent in June from 2.18 percent in May. Clearly,
this low number (CPI) and what it implies about
underlying price pressuresas well as the latest Index of
Industrial Production (IIP) data just releasedis
something that, I am sure, all policymakers will reflect
upon very, very carefully, Subramanian said in a
statement (read a Mint report here). The message from
Delhi to Mint Road cant be clearer than this.
In other words, Subramanian is saying: Look, inflation
has come down enough for you to cut rates now. No more
excuses.
Will MPC cut rates on 2 August? It is anybodys guess still.
If one goes by the rate panels rationale against a rate cut
in earlier policy statements, it wouldnt.

The fundamental reasons that has prompted Patel and his

fellow members to hold rates back then exists even now
a still relatively high core inflation, play of base effects on
the CPI numbers, the question of whether the recent dip in
CPI numbers is a temporary blip or not, lack of clarity on
the full impact of central allowances disbursal and
monsoon. Of these, one big factor is base effect, which has
played a significant role in the current declining trend. If
one looks at June last year, the overall CPI inflation was
5.77 percent (130.1 index) and in July it further rose to
6.07 percent (index 131.1). This means, in July, 2017 too,
inflation will have downward bias on account of base effect
in last year, probably pushing the print further down.
One question before the MPC could be what will happen
when the base effect reverses post-July (inflation started
dropping since August last year). This issue has been
highlighted by this writer in an earlier Firstpostcolumn .
On the other side, growth worries are growing. In the
March quarter, the gross domestic product (GDP) came at
6.1 percent, reflecting the state of economy particularly in
the aftermath of demonetisation. Later, the IIP (Index of
Industrial Output) data showed a decline to 1.7 percent in
May from 2.79 percent in April. In this context, the rate
panel has few options but to go for a rate-cut sooner or
later.
Not that a rate-cut will work wonders in the economy. As
this writer has said several times before, the underlying
problems faced by the Indian economy are much more
structural than higher borrowing costs. Banks are saddled
with high level of bad loans, private investments have not
picked up significantly and the manufacturing sector is
struggling to get back the desired momentum. Having
learned a lesson from the past, banks are not going to
shower money on unworthy borrowers even with a quarter
percentage point rate-cut.
All the above mentioned problems cant be wished away
with one monetary policy action. Bonds and equity
markets may rally for a while if Patel and team opt to go
for a 50 bps cut. Fundamentally, nothing really changes in
the economy with just one rate-cut.
But none of these reasons may be enough to convince the
rate cut lobby. During the UPA-regime, former union
finance minister, P Chidambaram had famously said that
the government will walk alone if need be, after the RBI
declined his request to cut rates then. Will we hear
something similar from incumbent finance minister, Arun
Jaitely? The MPC has so far refused to bend to pressure
from the government and has continued with what it
thought is right. It can hold the rates one more time and
keep the rate-cut announcement for October or it can
announce a quarter percentage cut this Wednesday and
get it over and done with. This time, a psychological game
between the MPC and government is on the cards, rather
than a work of macroeconomic data inputs and
assumptions.