Renewed rate cut hopes...

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 7^th 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…