Odds against rate cut

The latest inflation data as measured by Consumer Price Index (CPI) has slowed down to a record 1.5 per cent in June from 2.18 per cent in May. In fact, CPI is at its lowest since the country started releasing retail inflation data in January 2012 based on a combined CPI for rural and urban consumers.

This is also much below the Reserve Bank of India’s medium term target of 4 per cent. Falling inflation numbers are indicative of easing prices. A sharp fall in prices of vegetables, never mind the pain inflicted by tomatoes and pulses, has aided slowing of retail price inflation. Falling prices also reflect a demand slump.

A bumper crop has lowered the prices of farm produce, prompting farmers across the country to demand more remunerative prices. The index of industrial production (IIP) has decelerated from 3.1 per cent in April to 1.7 per cent in May. Output of the manufacturing sector decelerated to 1.2 per cent in May from a 2.6 per cent growth in April.

Mining output contracted to 0.9 per cent in May compared with 4.2 per cent in the previous month. Electricity generation, however, has increased to 8.7 per cent in May compared with growth of 5.4 per cent a month ago. A combination of slowing inflation and slowdown in factory output will ratchet up pressure on the Reserve Bank of India to cut interest rates.

The latest data has come out three weeks before the RBI’s monetary policy committee under Governor Urjit Patel meets to review policy. Chief economic adviser Arvind Subramanian has also done his bit by calling for a cut in policy rates.

“Clearly, this low number (CPI) and what it implies about underlying price pressure — as well as the latest Index of Industrial Production (IIP) data just released — is something that, I am sure, all policymakers will reflect upon very, very carefully,” Subramanian said in a statement, implicitly directed by the central bank.

Industrial production growth, which had shown traction in March, has been dragging over last three months now. The slowdown mirrors a subdued private investment climate and has triggered demand for the central bank to abandon its hawkish bias and cut interest rates August 2 to jump-start flagging corporate investment. But will Patel take the bait?

It seems unlikely, at least in a near to medium term. The central bank may opt to play some more wait and watch to decipher how the inflation trajectory evolves from July. There are a number of upsides to inflation risks that may begin to play out from this month.

The impact of higher housing rent allowances to government employees will come from July. The goods and services tax and higher food prices will start getting reflected in the inflation numbers from the end of this month or early next month. The looming threat of global uncertainty and expectations of further rate hikes in the US and withdrawal of easy liquidity policies in the euro zone will also work against a policy cut in the near future.

Most risk factors flagged in the previous policy — farm loan waiver, health of state finances, house rent allowances implementation, rural wage growth and global uncertainty — hold true now too. A fall in industrial production may be temporary.

It may have resulted from nervousness stemming from the GST rollout July 1. Many retailers were destocking their inventory before July 1, which led manufacturers to cut production. Things may come back to normal as the GST dust settles down. The dovish economic outlook has not deterred foreign investors who are buying into the country’s long term prospects.

There is robust foreign portfolio investment what with a rally in the equity markets. Strong inflows of dollars have helped keep the Indian rupee afloat. Added to all this, there is no change in the NPA level of banks. Monetary policy will not do much to improve the situation in key sectors such as steel, infrastructure and telecom. There is no guarantee that monsoon would behave on expected lines going forward. Odds are, therefore, not in favour of a rate cut.

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