BackPrices ease; will RBI cut rates now?
Weak rupee may make it difficult for central bank to cut policy rate despite deceleration in wholesale prices in May
Premium(Pradeep Gaur/Mint)
New Delhi: India’s inflation based on the Wholesale Price Index (WPI) decelerated further to 4.7% in May bringing some good news for policymakers, but a weak rupee, say analysts, is likely to make it difficult for the Reserve Bank of India (RBI) to cut rates in its policy review due on Monday.
Data released by the government on Friday shows that WPI inflation slowed to a 43-week low from 4.89% a month ago on account of a decline in the prices of fuel and manufactured products. Food inflation, however, saw an acceleration, led by an increase in vegetable prices.
In a signal that the government is clearly betting on RBI following through with another rate cut, Planning Commission deputy chairman Montek Singh Ahluwalia said, “They (RBI) should certainly consider it (easing inflation) because it is very clear that the underlying inflationary pressure is softening."
Although the inflation number does give RBI some space for monetary easing, analysts point out that it is unlikely to cut rates in its monetary policy review on 17 June, given the potential impact of the depreciating rupee on inflation. A weaker rupee makes India’s imports of fuel, pulses, edible oil and metals more expensive, and will have an impact on inflation in the coming months.
In the last few months, there have been signals that the economy is bottoming out. While factory output has reversed its contraction, both WPI and retail inflation have eased. But a sharp depreciation in the rupee could reverse some of these positives.
The rupee, which fell to a record low of 58.99 against the dollar on 11 June, has depreciated nearly 7.5% against the US currency since May, forcing the government and RBI to step in to calm nerves and announce a series of steps to curb gold imports, one of the main reasons for the widening current account deficit (CAD).
On Friday, the rupee recouped some of its losses to end trade at 57.53 per dollar, against the previous close of 57.98.
India’s CAD is projected to be more than 5% of gross domestic product in 2012-13, with oil and gold together constituting nearly 45% of the import bill.
Citi India economist Rohini Malkani said in a note that given the recent rupee volatility, elevated consumer price inflation and a high trade deficit in May, the central bank is likely to keep rates on hold in the forthcoming monetary policy review and go for a rate cut only at its 30 July meeting.
“Rupee and rains will be the two key factors to watch out for. Further rupee weakness could add inflationary pressures as tradeables account for 57% of WPI, while rains (28% above normal so far) bode well for food prices," she said.
The central bank cut the key repo rate by 25 basis points at its last policy review in May, but had warned that there was little headroom for further reductions, given the swelling CAD and high retail inflation. A basis point is one-hundredth of a percentage point.
Data released earlier this week showed that retail inflation remained high at 9.31% in May despite a marginal fall, and factory output grew 2.3% in April against a contraction of 1.3% during the same month a year ago.
Aditi Nayar, senior economist at rating agency Icra Ltd, agreed that the central bank was unlikely to go in for monetary easing at its forthcoming review.
“All categories with the exception of pulses have contributed to the sharper-than-expected uptick in food inflation. The considerable rupee depreciation is expected to boost prices of imported products in the near term, posing a concern for RBI," she said. “The higher under-recoveries of diesel are also expected to put pressure on inflation."
Nayar pointed out that concerns about the size and financing of CAD in the first quarter of the current fiscal, given the rise in gold imports and outflow of funds, would also put pressure on the central bank to adopt a wait and watch approach.
According to data released by the ministry of commerce and industry, in May, while food inflation increased to 8.25% from 6.08%, core inflation (non-food, non-fuel manufacturing inflation) came down to 2.4% from 2.6% in April. Fuel price inflation eased to 7.32% from 8.84% a month ago, helped by a fall in prices of coal and petrol. The government revised the March WPI inflation number to 5.7% from 5.96% earlier.
PTI contributed to this story.
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