Home / Politics / Policy /  Sharp drop in inflation stokes hopes of a cut in interest rates

New Delhi: A steep drop in wholesale price inflation to a 40-month low in March coupled with a sharp decline in gold and crude oil prices may have set the stage for a cut in the policy rate by the Reserve Bank of India (RBI) next month.

If that does happen, it could lead to a revival of the Indian equity markets in the next six months, experts said.

In March, core inflation, or inflation that excludes volatile food and fuel prices, also hit a 36-month low at 3.4%, remaining within the 4% tolerance limit of the central bank for the second month in a row.

While inflation based on the Wholesale Price Index (WPI) fell to 5.96% in March from 6.84% a month ago on account of decelerating prices of food and manufactured items, the price of gold fell to a 15-month low as more European countries indicated they would reduce their gold reserves. Crude oil prices also fell below $90 a barrel on the New York Mercantile Exchange, the lowest level in more than three months, as economic growth unexpectedly eased in China in the first quarter of 2013, the world’s second largest crude consumer. In response, oil marketing firms in India cut petrol prices by about 1, effective midnight Monday.

Still, some analysts warned that high consumer price inflation, or retail inflation, could stay RBI’s hand.

A weak equity market and high inflation have kept demand for gold high in India, leading to a burgeoning current account deficit (CAD) that, coupled with persistently high inflation, has prevented RBI from aggressively cutting policy rates to address growth risks.

India’s CAD worsened to a record 6.7% of gross domestic product in the third quarter (October-December) of fiscal year 2012-13 as growth in imports, mainly oil and gold, outpaced exports of goods and services. Though the government has announced further steps to attract foreign investment to finance the rising CAD, its steps to curb the import bill, especially gold, have not yielded the desired results.

“The fact that this is the first time (in over three years) it (inflation rate) is below 6% is very important and I hope that we will continue to see that often," Planning Commission deputy chairman Montek Singh Ahluwalia said. “I have to say that monthly numbers can jump around, but it has been our view that in a gradual way, inflationary pressure is coming down."

Reacting to the positive data, the benchmark S&P BSE Sensex index rose 0.63% to 18,357.80 points at the close. The index had dropped 300 points in the previous session. State Bank of India and Oil and Natural Gas Corp. Ltd, the nation’s biggest state refiner, were some of the big gainers. Among sector-specific indices, the oil and gas sector index gained the most, rising 2.37% to 8,561.17 points.

“With crude and gold prices falling, the pressure on our CAD will ease. This will help the rupee gain against the dollar. Many foreign investors may look to advance their purchases in anticipation of rupee’s appreciation," said V.K. Sharma, head of business (Private Broking and Wealth Management) at HDFC Securities Ltd.

“Overall, buoyancy seems to have returned to the equity markets in the absence of investment alternatives. But company results, expected to be announced over the next one-and-a-half months, may act as a dampener," he cautioned.

Kishore Narne, head of commodities at Motilal Oswal Commodities Broker Pvt. Ltd, said investors’ confidence in gold has been severely dented given the magnitude and the speed of the recent plunge. “The prospects of any meaningful recovery in gold remain weak, and given the lack of any major triggers in the near term, gold prices are unlikely to reverse the downtrend any time soon," he said.

A short-term recovery, Narne added, is entirely possible given the speed at which prices have declined towards 27,300 levels, and he anticipates another 12-15% drop in the domestic bullion market by March 2014.

The industry department revised the WPI inflation rate for January to 7.31% from the provisional figure of 6.62% released earlier, mostly due to the delayed adjustment for fuel price increases.

Prices are cooling faster than expected as a result of the sizable output gap in the Indian economy, Glenn Levine, senior economist at Moody’s Analytics, said in a research note.

“This easing in inflation is, broadly speaking, a good thing. It provides the central bank with scope to cut interest rates further should the economy fail to recover," he said.

India’s factory output slowed to 0.6% in February from 2.4% in January, signalling that economic recovery has yet to take firm root.

Rohini Malkani, India economist at Citigroup India, said that given the elevated level of Consumer Price Index (CPI) inflation at 10.39% and CAD, the central bank will go for a 25 basis points cut in its 3 May policy review, followed by a long pause. A basis point is one-hundredth of a percentage point.

Data released on Friday showed India’s retail inflation moderated in March, even though it continued to remain above the double-digit mark. In February, CPI-based inflation was 10.91%.

Madan Sabnavis, chief economist CARE Ratings, said the fall in the inflation rate was due more to a high base last year and he wasn’t sure the trend could be sustained.

He expected fuel price hikes, high minimum support prices (MSPs) and imminent pressure on food prices once the food security Bill came into force to put upward pressure on the inflation level.

RBI said in its mid-quarter policy review last month that even as the policy stance emphasized addressing growth risks, headroom for further monetary easing remained quite limited due to pressures stemming from MSP increases, the wedge between wholesale and retail inflation, and risks on account of the high CAD level.

Sabnavis does not expect any policy rate cut by RBI in its May policy review. “The wide difference between CPI and WPI remains a concern. RBI will keep a close watch on the inflationary trend and the underlying inflationary pressures, before cutting policy rates further," he added.

contributed to this story.

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