All eyes are on the RBI as the 17th of April approaches. RBI is scheduled to release the annual monetary policy for 2012-13 next week and there is lot of expectations from the policy. Markets are expecting the RBI to cut the benchmark policy rate, the repo rate by a minimum of 25bps in the policy. Markets believe that rate cuts will improve sentiments on equities, bonds and currencies, which are all having a tough time on the back of domestic and global economic worries.
Rate cuts apart, the RBI must be more realistic in its projections for various macro indicators this time around. The last annual policy released in May 2011 saw the RBI setting and missing its forecasts. Table 1 shows RBI forecasts set in the annual policy for 2011-12 and the actuals.
RBI has been revising its forecasts throughout fiscal 2011-12 but the fact is that RBI’s policy stance and its forecasts have not been in sync with each other. The fact that RBI was maintaining an extremely tight monetary stance should have made the central bank show lower GDP growth and lower monetary aggregates growth. At the end of fiscal 2011-12, inflation was higher than estimates and GDP growth, broad money supply (M3), credit growth and deposit growth were down sharply against estimates.
It is true that forecasting is an imperfect science and no forecaster has got it right so far on a sustained basis. However there has to be some correlation between policy actions and forecasts. Last year even as the repo rate was being increased sharply higher, growth estimates and estimates of monetary aggregates of (M3), deposit and credit growth lagged. The RBI in fact had to cut the CRR (Cash Reserve Ratio) to ease liquidity in the system as monetary aggregates trailed estimates.
What should be the projections for 2012-13?
On the assumption that RBI will ease the policy rate of repo by at least 100bps in 2012-13 and maintain an accommodative monetary stance, the projections for macro and monetary aggregates should be higher. The assumption for maintaining a soft policy stance is that inflation is not a big threat to the economy and the bigger threat is slowing economic growth. RBI can take a leaf out of the US Federal Reserve’s (Fed’s) book, which has placed more importance to growth and has pledged to keep monetary policy ultra loose till late 2014 even as inflation is expected to remain at below tolerance levels. India has its own problems and hence not fully comparable with the US, but the fact is that the monetary policy goal for the Fed is clear and RBI should also have a clear cut policy stance.
Table 1. shows the expected projections by the RBI for the macro and monetary aggregates. Consistent with its accommodative policy, GDP growth and monetary aggregates are projected higher. Inflation should not be expected to go down sharply as policy is accommodative and oil prices are still ruling at higher levels. However given the below trend growth forecasts, the issue in the economy is of weakening aggregate demand and this drop in demand will keep inflation in check. If inflation does trend down sharply, RBI will have room to cut policy rates sharply.
RBI should not be expected to stick to its forecasts throughout the year but forecasts should broadly be in line with policy actions rather than policy actions being driven by forecasts going wrong.