Will Feb WPI make Subbarao think twice about a rate cut?

Inflation, as represented by the wholesale price index( WPI), has come in at 6.95 percent for February, higher than market estimates. What will this mean for RBI governor D Subbarao's intent to cut interest rates?

For sure, he will have to keep four things in mind:

One, month-on-month inflation is still lower than the average of the past two years. After averaging above 9 percent in 2011, inflation has cooled to 6-7 percent in the past three months. As a trend, that is heartening, but the good news stops there.

Most experts believe Subbarao will wait for the Budget to be unveiled to find out what steps the government will take to curb the ballooning fiscal deficit. Reuters

Two, the threat of food and fuel prices surging again remains high. The favourable 'high base' effect in the case of food prices is expected to start receding soon, while international crude oil prices are already high (Brent crude is currently ruling at more than $120 a barrel).Since India imports about 80 percent of its crude oil requirements, the country is particularly vulnerable to volatile oil prices.

Already, petrol prices face an imminent hike of up to Rs 5 per litre; price hikes in diesel and cooking gas might not be far behind if the government attempts fiscal consolidation by trying to reduce fuel subsidies. Plus, a service tax expected to be announced in the Union Budget will raise prices for a whole boatload of services. The result: a renewed push to prices from various fronts. That will make Subbarao cautious about becoming too aggressive on cutting rates.

Three, the rupee's volatility raises the risk of 'imported inflation'. The rupee is currently trading at 50 to the US dollar. A volatile currency will make the governor doubly cautious about cutting rates too much too soon.

Four, economic growth has weakened considerably. Economic growth slowed to 6.1 percent in the quarter ending December, the slowest in nearly three years. Business investments have slowed to a trickle, which is exacerbating the supply-side issues of the economy. The RBI will be mindful of that.

So what's the verdict?

All things considered, the RBI might wait until April before announcing its first policy rate cut, especially since global oil prices are high. Most experts believe Subbarao will wait for the Budget to be unveiled to find out what steps the government will take to curb the ballooning fiscal deficit, although it's highly likely the governor already knows the broad contours by now.

The governor has waited a long time to get some clear signs that inflation is coming under control; the February data will give him no reason to celebrate. In addition, the February figure is provisional, and provisional figures are usually lower than the final figures.

The December WPI has already been revised higher to 7.74 percent from an earlier provisional 7.47 percent, which does not bode well even for the February data. In all likelihood, we might find out three months later that inflation crossed 7 percent in February.

Even if we do get policy (repo) rate cuts over the next few months, they are likely to be short-lived.

In any case, the job of the RBI governor just got a little more tougher.

For the WPI release, please click here.