CPI inflation at 1.54%: CEA Subramanian can make his case but a rate cut is unlikely soon

Almost every time when the inflation shows a major drop, the Union government routinely voices its demand for a rate cut from the central bank. That has been a practice for long no matter whether it is UPA or NDA in New Delhi. Typically, this comes from the Union finance minister, one of the senior technocrats in the government or the Prime Minister’s Office.

This time around, it is chief economic advisor (CEA) Arvind Subramanian who has shot the demand, making a strong case for a rate cut in the wake of consumer price inflation for the month of June falling to 1.54 percent, down from 2.18 percent in the previous month. The CEA has his reasons right when asking for a rate cut, but the MPC (monetary policy committee) may have theirs to contest this.

Chief Economic Advisor, Arvind Subramanian. PIB

Chief Economic Advisor, Arvind Subramanian. PIB

Let’s look at the numbers. It is a fall in food and vegetable prices that has contributed to the fall. The core inflation, non-food, non-oil manufacturing inflation, too showed a decline to 4.03 percent from 4.25 percent. That is a significant easing trend considering the 4 percent medium target of the central bank. This is the first time the CPI inflation has fallen below the 2 percent lower band of the inflation targeting policy. The upper band is 6 percent.

According to a report by SBI, the CPI is likely to remain ‘sub-2 percent for the next month, sub-3 percent for August-September and sub-4 percent for Ocober-Nov’17 and 4-4.5 percent between December and Mach’18. For FY18, CPI inflation average could thus be below 3.5 percent with a downward bias.’

But, does this mark the end of central bank’s prolonged inflation fight? Are we now looking at a phase of disinflation sustaining ahead?

The chances for this are less for the simple reason that base effect has played a significant role in the current declining trend. If one looks at June last year, the overall CPI inflation was 5.77 percent (130.1 index) and in July it further rose to 6.07 percent (index 131.1). This means, next month (July, 2017) too will have downward bias on account of base effect in last year, further pushing the print down.

“Notwithstanding the recent lull, the monsoon dynamics have been reasonably favorable so far, which has contributed to a surge in sowing of most crops other than jute as on 7 July, 2017. Prices of a number of food items such as pulses, vegetables (barring tomatoes) and oils remain weak on a seasonally adjusted basis so far in July 2017 and the positive base effect for food inflation is expected to continue in July 2017,” said Aditi Nayar, principal economist at ICRA rating agency. In a note, rating agency Care too maintained its forecast of CPI inflation moving towards 4.5 percent mark towards the end of the year.

As these agencies point out, the question before the Monetary Policy Committee is what will happen when the base effect reverses post July (inflation started dropping since August last year), the full effect of the GST implementation and central allowance distribution for employees plays out in full and the monsoon trend. The rate panel may choose to hold back the rate cut bonanza till October until it gets a clear trend.

In the past, the MPC has shown who the boss is when it comes to deciding the course of interest rates by refusing to meet the finance ministry officials before the monetary policy decision. It may not be easy to continue with resistance too long given that there are concerns on the growth front. The GDP for the March quarter came at 6.1 percent in January-March quarter and the IIP slowed to 1.7 percent in May from 2.79 percent in April. The rate panel will have to yield sooner than later to cut interest rates. It has tough days ahead.

Published Date: Jul 13, 2017 02:59 pm | Updated Date: Jul 13, 2017 03:03 pm

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