The Consumer Price Inflation
(CPI) has fallen to decades low of 1.54 % in June on the back of prudent supply
management of food items and demonetization that resulted in low demand and
growth, which have caused higher capacity and inventories of the firms turning
up in lower prices and inflation. The economy is facing a situation of excess
capacity, partly due to slowdown in investment; investors are waiting for lower
interest rates, and partly due to slow recovery in real wages, incomes and demand
because of higher inflation in the past, which led to a tightening in the
interest rate and wages. However, the Reserve Bank of INDIA had committed a
neutral or data dependent stance in order to justify further actions and
maintain credibility, it said that it would consider inflation data for few
months to take a rate cut call, it wanted proof that lower inflation is stable
so it does not contradict its actions later and affect credibility. However, to
fine tune the economy and achieve a “neutral or natural” real rate, that
neither inflates nor deflates the price-level, has been viewed by the Monetary Economist, as “ideal”,
in other words, to match demand and supply for stable prices. As has already
been discussed before, INDIA is going through a period of excess capacity,
which invites measures to increase demand which has suffered since higher
interest rate has put a lid on investment spending and lower real wages and
income have put a hold on consumption spending and both have resulted in excess
capacity and savings also due to inflation and inflation expectations, which
are now changed to deflation and deflation expectations and that need rate cuts
to increase spending, both investment and consumption, the deflation or
disinflation and same expectations might also incentivize people to consume or
spend and save and invest, more. The RBI probably tried to increase investment
by communicating an end to rate cuts and rate cuts expectations, but lower
inflation or disinflation or deflation has renewed hope for further rate cuts
across all the sections. The Chief-Economic-Advisor has had been most vocal
about inflation forecasting errors and demanding a rate cut, he says that
situation warrants a rate cut on a substantial basis. Nonetheless, the
government too might help increase demand through speedy implementation of the 7th
Pay Commission and wage spending, which are likely to increase real incomes,
when prices are below the RBI’s lower target band at 2%, prices have gone below
the central bank’s target, so it must been seen that, now, how the RBI is going
to handle the novel situation? The Economists view forecasting and proactive
policies as vital for more credible monetary policy; they help avert a problem
even before a problem arrives… Nonetheless, under the new conditions the
situation might lead to change in the RBI’s stance to accommodative and rate
cuts and rate cuts expectations…
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