WPI inflation at 5-year low: Four reasons RBI will not be convinced to cut rates on 2 December

Photo: India TV (Edited)

[Editor: This report is somewhat confusing to the common man or man on the streets. Let me try to put my point of view as against what is written here. This article stresses on WPI (as a basis of rate cut by the RBI), which has fallen to a five-year low of 1.77 percent, but misses the point that consumer price inflation had also simultaneously dropped to 5.52 per cent in October, below the Reserve Bank of India's (RBI) 6 per cent target for January 2016. The report quotes, India Ratings who said in a note: 

"the trajectory of inflation/inflationary expectations is still somewhat fuzzy in view of (i) waning of base effect after December 2014 and (ii) absence of clarity with respect to commodity particularly crude prices (is it a 'new normal')." The RBI would want to wait until clarity emerges on this front". But if any Central Bank is not able to anticipate clearly the inflation projection, even after such stark-naked facts and figures, then I would call the said action to be yokelish.  

The report again quotes, India Ratings as:

 "However, there are still certain food items which are witnessing very high to high double digit inflation for past several months. For example, over the past six months, inflation in fruits has ranged between 19% and 31%, in milk between 9% and 12% and in potato between 37% and 90%," it notes. But, there is no guarantee that the price will rise further or whether it has peaked out. Hence, this cannot be a basis for  gauging the future inflation projections. Right?

This article further says:

What has brought the prices down is not steps taken by the government. It is mostly because of the seasonal and global factors. For instance, seasonally this is the time when vegetable prices fall. Among global factors is the fall in crude oil prices.

But we are comparing on Y-o-Y figures, isn't it? Or in other words if seasonally vegetable prices fall this time of the year, then last year also, the same thing might have happened, isn't it? So, this factor just cancels out each other when we are considering yearly figures. Right?

Another point which is worth noting is that consumer goods output - a proxy for consumer demand that drives 60 per cent of India's economy - has grown in just two of the last 21 months. It fell an annual 4.0 per cent in September. 

At end my argument is that the RBI should cut the Repo rate to indicate their success on broad spectrum management of inflation. The fact is that 25 basis points cut of Repo by the RBI does not mean  much, but its direction is important as this might give a good signal to the India Inc. Moreover, holding of Repo rate by the Central Bank, has not worked in tandem with the rate cuts by the banks, recently in their FDs, because of slowing of credit growth. Therefore, Dr.Raghuram Rajan should look at these vital parameters and go for at least 25 basis points cut in the Repo rates. Besides, the government should quickly bring FDI in multi-brand retail so that the effect of middle-man is reduced and have a tight grip on the inflation monster. Bond traders are betting on one of the biggest interest rate reductions among major emerging markets once the rate cutting cycle begins. The 10-year benchmark bond yield had dropped 36 basis points since Oct. 1 until the last session on hopes of a rate cut] 

Nov 15, 2014: Wholesale price index-based inflation is suddenly the flavour of those who are routing for an interest rate cut by the Reserve Bank of India. This is because the print falling sharply and in October it fell to a heart-warming five-year low of 1.77 percent.

The fall has been helped by slower annual rises in food and fuel prices.

As per the data, food articles inflation stood at 2.70 percent and that in fuel and power at a low 0.43 percent. Vegetables have witnessed a price decline of 19.61 percent, while fruits prices have stubbornly risen 19.35 percent.

"With inflation at or under 6 percent we think RBI is likely to face pressure to ease, not just from the government, but also from RBI's own policy committee," Devika Mehndiratta, a senior economist at Australia and New Zealand Banking Group Ltd in Singapore, has been quoted as saying in the report.

The fact is RBI governor Raghuram Rajan have been under pressure to cut rates for quiet sometime now.

“Since Indian aggregate demand remains weak, and output is much below potential, if the glide path for inflation looks achievable, rates should be cut,” Ashima Goyal, professor of economics at Indira Gandhi Institute of Developmental Research had recently told The Economic Times. Goyal is also a member of the RBI's Technical Advisory Committee (TAC), the panel that advises Rajan on monetary policy.

Majority of the members of this committee has time and again advised the RBI to cut rates, but Rajan has proved that he is his own man.

Despite the clamour for rate cuts, which has just risen to deafening levels, Rajan is not likely to cut the policy rate in its 2 December review.

Here are three reasons:

For one, the decline in inflation is on high base. As India Ratings said in a note yesterday, "the trajectory of inflation/inflationary expectations is still somewhat fuzzy in view of (i) waning of base effect after December 2014 and (ii) absence of clarity with respect to commodity particularly crude prices (is it a 'new normal')." The RBI would want to wait until clarity emerges on this front. It is not just inflation that is worrying, it is also the inflationary expectations of the households.

Secondly, food inflation, which was one of the main concerns for the RBI, is falling but there is no reason to believe that it is sustainable. This is because the full impact of this year's deficient rains is yet to reflect in the prices. India Ratings notes at 2.7 percent, food inflation in October is the lowest since February 2012. "However, there are still certain food items which are witnessing very high to high double digit inflation for past several months. For example, over the past six months, inflation in fruits has ranged between 19% and 31%, in milk between 9% and 12% and in potato between 37% and 90%," it notes. Moreover, there are reports of heavy unseasonal rains in certain regions. However, there have not been any reports on crop damage yet.

Thirdly, what has brought the prices down is not steps taken by the government. It is mostly because of the seasonal and global factors. For instance, seasonally this is the time when vegetable prices fall. Among global factors is the fall in crude oil prices. "While seasonal factors could have a transient impact leading to sharp swings in the headline inflation in either direction, structural factors keep inflation stubborn; concerted efforts will be required over the medium term to sustain inflation at low levels," India Ratings notes. As per the ratings and research agency the structural factors that are impacting inflation are stagnating productivity, rising cost of cultivation, changing food consumption pattern and supply shock being exploited by intermediaries. The government has not taken any action to address these factors, without which the RBI is unlikely to be convinced of sustaining the present low level of inflation.

Fourthly, movements is wholesale price inflation do not really figure in the RBI's scheme of things, when it comes to monetary policy formulations. The central bank has officially accepted retail inflation as its key price indicator to decide the course of policy decisions.

Courtesy: Firstbiz.com