Positive macroeconomic signals may lead to stimulus withdrawal

Positive macroeconomic signals may lead to stimulus withdrawal

The Wholesale Price Index (WPI) inflation continues to surge and despite a slight fall, food inflation remains high. This along with stronger-than-expected growth recovery is raising expectations of an early exit from an accommodative policy. We, however, do not expect any rate change at least until the April credit policy.

In line with our expectations, WPI inflation surged to 8.56% in January, up from 7.31% in December.

Inflation for November was revised upwards to 5.55% (from 4.78%).

Indices for primary articles and manufactured products increased by 0.2% and 0.7%, respectively, while fuel inflation jumped 1.8% sequentially in January.

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On an annual basis, overall food inflation (primary and manufactured) eased to 19.4% in January from a decade high of 21.9% in December. The primary food index fell by 0.7% while manufactured food index rose by 1.6% in January.

The food index has a weight of 27% in the overall WPI and much higher weightage in the Consumer Price Index (50%). That is why elevated food prices continue to raise concern. We estimate that food inflation has already peaked. The second-advance estimate of agro production by the agriculture ministry indicates another bumper rabi crop. We, thus, expect food prices to start softening from March-April onwards. The firming up of non-food inflation—non-food primary, fuel as well as manufacturing—is, however, likely to continue. We expect WPI inflation to peak at around 9% in March.

Despite widespread expectations about the hike in administered fuel prices, we do not expect such steps to be initiated in the near future. Yet, the unfavourable base would continue to elevate fuel inflation until May.

Higher-than-expected real growth and high inflation is creating expectations of an early and speedy exit from both monetary and fiscal stimuli. That inflation has marginally crossed the Reserve bank of India’s (RBI) estimate for March inflation (8.5%) has heightened concerns about an inter-policy rate hike. Our estimates suggest only modest hardening of inflation in the next two months and a slight loss of steam in the third quarter of FY10 gross domestic product as well as industrial production growth in the next two months. These developments are likely to reduce pressure on RBI to undertake policy tightening.

We still expect that the April policy would be the earliest opportunity for RBI to consider a policy rate hike.

Graphics by Yogesh Kumar / Mint