Rising WPI inflation could tie RBI’s hands

New Delhi: The wholesale price index (WPI), the most closely followed gauge of price rises in the economy, accelerated to a six-month high in August, leaving little room for new Reserve Bank of India (RBI) governor Raghuram Rajan to initiate any monetary easing in his first policy review on Friday.

add_main_imageInflation as measured by the WPI quickened to 6.1% year-on-year last month from 5.79% in July, on the back of rising food prices, data released by the government on Monday showed.

Food price inflation in August soared to a three-year high of 18.18% from 11.91% in July, led by a 244% surge in onion prices. Although fuel inflation remained almost unchanged at 11.34%, core inflation—a measure that excludes volatile food and fuel prices—eased to 1.97% from 2.33% in July, supported by a decline in price of products for which India depends on imports.NextMAds

The June inflation rate was also revised upward to 5.16%, from the provisional figure of 4.86%, implying a possible upward revision of the August number as well. Retail inflation, as measured by the consumer price index, had slowed for the second month to 9.52% in August from 9.64% in July.

Inflationary pressures remain high although economic growth slowed to a four-year low of 4.4% in the June quarter of the current financial year. Growth in private consumption slumped to 1.6% during the quarter, prompting industry lobbies to call for policy rate cuts by RBI to support growth.

Despite the significant slowdown in economic growth and benign core inflation, the depreciating rupee has prevented RBI from paring interest rates to support growth. Growth in India’s economy, Asia’s third largest, slowed to 5% in the year ended 31 March, the slowest pace in a decade. Since January this year, the rupee has weakened 12.49% and has lost the second most among Asian currencies during that period, after the Indonesian Rupiah.

Most analysts do not see any shift in RBI’s focus on stabilizing the rupee and fighting inflation when the central bank holds its first policy review under Rajan, who succeeded D. Subbarao as RBI chief on 5 September.

Abheek Barua, chief economist at HDFC Bank Ltd, said that though not much action on the monetary policy front is expected on Friday, there could be considerable clarity on RBI’s stance. Barua expects RBI to take some “less visible measures” such as reducing the mandated 99% of the cash reserve ratio that banks are required to keep with RBI on a daily basis—part of the measures announced to shore up the rupee. sixthMAds

The cash reserve ratio is the percentage of deposits that banks are required to keep with the central bank.

Although a set of positive numbers last week, including a pick-up in factory output and double-digit export growth for a second month on the trot, were seen by some economists as the first green shoots of recovery, most analysts have maintained caution.

Before he reveals his monetary stance, Rajan will have to first deal with the impact of the monetary tapering the US Federal Reserve is expected to announce on Tuesday or Wednesday. Fears of an expected policy tapering have already sparked an emerging market sell-off, contributing to the rupee’s fall to recent record lows.

The Fed is expected to reduce its $85 billion a month bond-buying programme, but financial markets are uncertain about the extent of the reduction.

In his inaugural address to the media, Rajan emphasised RBI’s role in ensuring monetary stability, suggesting that he would not adopt any softer stance on inflation in favour of growth. “Ultimately, this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the currency, from supply constraints or demand pressures,” he said.

On Monday, share prices rose in opening trading, joining a rally in Asian equities on the news that Lawrence Summers had dropped out of the race to head the US Federal Reserve, but the rise in inflation eroded all gains and key indices ended little changed.

Analysts said Summers opting out of the race relieved some investor concerns about a faster withdrawal of economic stimulus in the world’s largest economy.

BSE’s 30-share Sensex rose as much as 1.79%, or 353.67 points, to 20,086.43 in early trade, but pared most of these gains and closed 0.05%, or 9.71 points, higher at 19,742.47 points. The National Stock Exchange’s wider benchmark Nifty closed 0.17%, or 10.05 points, lower at 5,840.55 points.

The rupee on Monday ended at a one-month high but the rally was checked by the increase in wholesale price inflation. The partially convertible rupee closed at 62.8475 per dollar on Monday, up 1.03% from its previous close of 63.495.

Capital market regulator Securities and Exchange Board of India’s decision to do away with the debt auction mechanism for foreign institutional investment “is a welcome step and its reflection we have seen on the rupee. Global markets are less risk averse now, that is also helping the rupee,” said Anindya Banerjee, currency analyst at Kotak Securities Ltd.

British bank HSBC Holdings Plc. downgraded Indian stocks to underweight on Monday from neutral after the recent sharp rally in Indian equities.

“After the recent bounce, India looks relatively expensive and is most exposed to growth adjustments. We therefore take India down another notch to underweight from neutral, after the recent rally,” Garry Evans, global head of equity strategy, and Devendra Joshi, equity strategist, Asia Pacific at HSBC said in a research note.

The Prime Minister’s economic advisory council in its economic outlook, released last Friday, said the central bank has to continue its current policies until the rupee stabilizes.

asit.m@livemint.com

Reuters contributed to this story.