Photo: Mint

Photo: Mint

Lower inflation in July not enough for a rate cut

Lower inflation in July not enough for a rate cut

Last week, the Wholesale Price Index (WPI) for July came in surprisingly below expectation and on Tuesday, the retail inflation barometer, Consumer Price Index (CPI), followed in WPI’s footsteps and also came in lower. The latest WPI at 6.87% and CPI at 9.86% suggest that prices in the economy or inflation may indeed be cooling off.

Inflation has been under critical watch as high interest rates are hurting economic growth. As part of its inflation and monetary management, Reserve Bank of India (RBI) raised policy rates 13 times before relenting to growth pressures recently and cutting the repo rate by 50 basis points (bps) in April 2012. However, since then, given that inflationary pressures have not eased, RBI has chosen to maintain key rates.

The latest inflation numbers show some respite, but is this enough to raise the probability of a rate cut in next month’s monetary policy review? Or is there a need to establish a more sustained downward trajectory on inflation—after all food inflation remains high and fuel isn’t likely to get any cheaper. Experts are not very optimistic on rate cuts before the end of this year.

Lower inflation not yet comforting

All experts we spoke to suggest that it will take more than a lower headline inflation number for RBI to act decisively on lowering interest rates. Says Dinesh Thakkar, chairman and managing director, Angel Broking Ltd, “I don’t think there is high probability of a rate cut to come through next month. The central bank will watch out for the impact of monsoon and then take a call."

Photo: Mint

The risks clearly come from the fact that the poor monsoon this year will impact the winter crop negatively, thereby contributing to higher food prices. Additionally, fuel prices will remain high, thanks to international crude prices sticking around the $100 per barrel mark. Of course, there is the domestic matter of easing the fiscal burden and raising diesel and liquified petroleum gas (LPG) prices may be a part of the solution.

Then there is the matter of core inflation moving up. Says Rajesh Cheruvu, head (investment strategy), RBS Pvt. Banking (India), “While the headline is lower, the rise in core inflation despite stable currency is worrisome. Don’t expect any immediate action on rates, we could see a 25-50 bps cut towards the end of the last quarter in this calendar year."

Government policy to be the real trigger

In recent months, the focus has really shifted to government policy and what steps can be taken to facilitate and rejuvenate economic growth. This will also help ease inflationary pressure from manufacturing and possibly food. Says Cheruvu, “From recent interactions, we gather that RBI may be willing to cut rates despite high inflation if government policy action or changes get effected by year end."

Says Lakshmi Iyer, head (fixed income and products), Kotak Mahindra Asset Management Co. Ltd, “What steps the government might take on policy action is still a question mark. A diesel price hike is most talked about but that will only add to inflationary pressure, so it’s really not an easy decision for the central bank." Iyer says that data on gross domestic product (GDP), which will come by August end, and also next month’s inflation data will have to be watched for any decision on rates.

So, for now, in all likelihood you won’t see any respite in high loan rates from banks. Wait for inflation to ease further and in a more sustained manner before you can expect any easing.

lisa.b1@livemint.com

Close