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RBI may cut policy rates as WPI inflation eases

Economists expect a 25 basis points rate cut by RBI to bolster India’s faltering industrial growth
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First Published: Mon, Jan 14 2013. 09 32 AM IST
Industrial production contracted 0.1% in November after growing at 8.3% in the previous month.
Industrial production contracted 0.1% in November after growing at 8.3% in the previous month.
Updated: Mon, Jan 14 2013. 11 21 PM IST
New Delhi: India’s wholesale-price or WPI inflation eased to a three-year low in December, boosting chances of a rate cut by the central bank.
Retail prices, however, rose for the fourth month in a row and will force the Reserve Bank of India (RBI) to keep a close watch on price pressures in the economy.
Wholesale-price inflation decelerated to 7.18% in December from 7.24% in the preceding month, while retail inflation increased to 10.56% in December from 9.9% a month earlier.
The so-called core inflation, or non-food manufacturing inflation that is keenly watched by RBI, plummeted to a 33-month low to 4.19% in December, close to the central bank’s comfort level of 4%.
The RBI has indicated it may start supporting growth by cutting policy rates on 29 January, when it meets with its new deputy governor Urjit Patel to review its monetary policy.
Patel took charge at RBI on Monday.
After a strong rebound in October, when the Index of Industrial Production (IIP) grew 8.3% on a low base, it contracted 0.1% in November due to the Diwali holidays.
Growth in Asia’s third-largest economy in April to September slipped to 5.4% compared with 7.35% in the same period a year ago.
High inflation has forced RBI to keep rates unchanged after a rate cut of 50 basis points (bps) in April last year, crimping investment and consumer spending. One basis point is one-hundredth of a percentage point.
A rate cut at this stage will improve investor sentiment, but it is unlikely to lead to a significant economic recovery, according to Abheek Barua, chief economist at HDFC Bank Ltd.
“A small rate cut may not force banks for a change in effective lending rate since the liquidity situation remains tight,” Barua said. “Even a 75-100 bps rate cut over a year’s time may not be enough for effecting a turnaround in the investment cycle. The government needs to address the barriers to capacity-addition.”
The Organization for Economic Co-operation and Development or OECD, a club of rich nations, Monday said there are tentative signs of a turning point in economic activities in India and China. India’s composite leading indicator rose to 97.9 in November from 97.8 a month earlier.
RBI may also draw comfort from the fact that the provisional wholesale-price inflation data for October was revised lower to 7.32% from 7.45% estimated earlier, implying a moderation in price rise.
While rise in wholesale prices declined mostly due to softening prices of manufactured goods, the acceleration in retail inflation was caused by rising food prices. Retail food prices rose 13% in December from 11.8% a month earlier. Wholesale food inflation also remained elevated, mostly as vegetable prices rose 23.25% in December after having contracted 1.19% in November. This was chiefly because onion prices rose by 69.24% in December from 17% a month earlier.
Wholesale and retail price inflation have taken opposite paths since September. This divergence is primarily because of the composition of the two indices. While retail inflation gives around 50% weight to food, beverages and tobacco, manufactured goods occupy 65% weight in wholesale price rise.
Although it will take time for wholesale prices to drop significantly, it is difficult to imagine that RBI will focus only on it, ignoring the fast depleting core inflation, according to Yes Bank Ltd chief economist Shubhada Rao.
The government is also considering an increase in diesel and cooking gas prices to curb a burgeoning subsidy bill, which could further push inflation.
“While high food inflation and fuel price adjustments will pose short-term challenges to inflation trajectory, in the medium- to long-term, fuel price hike will have positive impact on the fiscal situation as the government addresses short term supply constraints,” Rao said.
Food inflation is likely to creep higher as the full effects of a deficient monsoon season cut crop yields, pushing up prices, Moody’s Analytics wrote in a research note. “The government will be cognizant of this; next year is an election year and food inflation can topple governments in India,” it said.
Although the threat from retail inflation remains, considering the weak investments and the country’s slowing economic growth, RBI is expected to support growth and opt for rate cuts to bring in liquidity and strengthen investment cycles, said Madan Sabnavis, chief economist at CARE Ratings.
“There is an 80% probability of a reduction of 25 basis points this month,’ Sabnavis said. “The balance 20% hinges on importance placed on the CPI (consumer price index) number.”
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First Published: Mon, Jan 14 2013. 09 32 AM IST
More Topics: Inflation | RBI | WPI | Rate cut | Interest rates |