New Delhi: Inflation accelerated in August on higher food and energy prices, and will likely be spurred further by the increase in the price of diesel, reducing the room for the Reserve Bank of India (RBI) to cut policy rates to shore up faltering economic growth.
The Wholesale Price Index (WPI), the most widely tracked measure of inflation in India, rose 7.55% from a year earlier and from 6.87% in July, the industry department said on Friday, ahead of Monday’s monetary policy review by the central bank. The inflation rate for June was revised to 7.58% from the provisional figure of 7.25% reported earlier.
After cutting its key policy rate by half a percentage point in April, RBI has resisted pressure from the government and industry for further rate reductions to boost economic growth, citing persistently high inflation and the lack of progress in narrowing the fiscal deficit.
Rs.5 a litre, rejigged the excise rates on petroleum products, and set an annual cap of six cylinders of subsidized cooking gas per household. The government expects to save Rs.20,300 crore on its subsidy bill, but the move may boost inflation further.
Factory output stagnated in July, with the Index of Industrial Production rising a minuscule 0.1%, and merchandise exports contracted for the fourth consecutive month at 9.7% in August, reflecting the economic downturn. Asia’s third largest economy grew 5.5% in the quarter ended 30 June, after falling to a nine-year low of 5.3% in the three months ended 31 March.
On Friday, Planning Commission deputy chairman Montek Singh Ahluwalia said the government could also have raised taxes or cut Plan expenditure to create the fiscal space for interest rate reductions.
“I am glad we have not done that. The rest is up to RBI,” he said.
Inflation accelerated faster than expected in August. It was higher than all 35 estimates in a Bloomberg survey, which made a median projection of 7.1%.
Although inflation indicators provide no justification for rate cuts on Monday, RBI could justify monetary easing by pointing to government action on the fuel price front to reduce the deficit and decisions on Friday to allow foreign investment in multi-brand retail and letting overseas airlines buy a stake of up to 49% in domestic carriers, said Rohini Malkani, an economist at Citigroup Inc.’s India unit.
Malkani maintains that despite inflation likely remaining well above RBI’s medium-term target of 4-5%, the central bank may cut the policy rate by 50 basis points (bps) in the second half of the fiscal year to stimulate economic growth. A basis point is one-hundredth of a percentage point.
In a report Malkani said that she maintains her forecast of inflation averaging 8% in fiscal 2013. “Despite the price hike, retail prices are still below international prices and consequently suppressed inflation remains high at 340 bps,” she said.
Analysts say the first-round impact of the diesel price increase on inflation will be 60-65 bps on WPI.
For consumers already reeling under high prices, the diesel price increase will cause more pain in the short term, at least as prices of basic necessities increase, said Rashid Bilimoria, chief executive officer of consumer research firm BluFin.
Bilimoria said the hope is that the positive effects of fiscal consolidation, followed by improving economic activity, should be visible soon enough in terms of Indian consumers’ expectations of the overall economic environment, employment perceptions and personal financial outlook.
“For the Indian consumer to feel more comfortable with this new reality, the message that needs to be clearly communicated by policymakers is that short-term pain will lead to long-term gain,” he said.
What may prevent an immediate rate cut is the high level of manufacturing inflation, excluding food items, that has again started picking up, touching 5.58% in August.
Although she does not expect a rate cut by RBI on Monday, “support from prudent fiscal management would create room for RBI to address growth risks”, Yes Bank Ltd chief economist Shubhada Rao said. “Accounting for other expenditure and revenue slippages, we maintain our view of the fiscal deficit coming in at 5.9% of GDP (gross domestic product) versus the government’s target of 5.1%,” she wrote
Rao said the third round of open-ended quantitative easing announced by the US Federal Reserve late on Thursday along with the unlimited bond-buying plan by the European Central Bank will continue to put upward pressure on global commodity prices and drive up imported inflation.
“The balance of risk on inflation could still remain somewhat on the upside despite the waning of monsoon risks,” she said, referring to fears of a deficient monsoon that have been alleviated.
Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, said the quantitative easing by the Federal Reserve may prompt enhanced global risk appetite in the near term, and lead to an increase in investment flows into India, boosting the equities market and driving up the rupee.
“However, given continued risks of policy implementation on the European side and with the ‘fiscal cliff’ in the US, sustained risk appetite is unlikely,” he added.
Kirthi V. Rao contributed to this story.