Not sorted yet: Inflation is at 5.5% but RBI may not cut rates before April

The sharp fall in consumer price index (CPI) inflation in October to 5.52 percent from 6.46 percent in September has given more firepower to those who bat for a rate cut from the Reserve Bank of India (RBI) as early as in the 2 December bi-monthly monetary policy review.

Their expectations are not totally unfounded given that the fall in overall CPI number has been accompanied by substantial decline in food inflation in the recent months. Food inflation declined to 5.59% in October from 7.67 percent in September and 9.42 percent in August. Similarly, a notable drop in the core food inflation number too has added to the optimism.

Taking a closer look, within the food inflation, prices of vegetables have eased by 1.45 percent in October even as that of fruits remain in double digits.

Falling inflation numbers, especially in the prices of food items, would have indeed given more confidence to Raghuram Rajan to believe that inflation will stick to the gliding path conforming to the central bank’s targeted path (8 percent by January 2015 and 6 percent by January 2016).

But there are still reasons to believe that chances for the much awaited rate cut open only in April next financial year.

For one, part of the reasons for retail inflation substantially easing in the recent months is the so-called base effect.

A higher base in the corresponding period in last year would show a lower number this year even though the rate of actual increase is same. In October last year, the CPI stood at 10.09 percent.

The benefit of higher base last year will continue in November as well, but will gradually vanish thereafter. How will the inflation pattern behave then is something Rajan would probably like to wait and watch.

Secondly, the RBI has stressed in the past that the apex bank wouldn’t give in in its fight against inflation unless it is fully convinced that food inflation eases in a sustainable manner for sufficient period braving the cyclical risks. Vegetable prices tend to rise towards summer. Also, the impact of a lower-than-expected monsoon on the crop pattern will be visible in the months ahead.

Thirdly,__ inflation expectation of Indian households still remains high. The RBI’s inflation expectations survey of households for September 2014 showed that the proportion of respondents expecting general price level to rise by ‘more than current rate’ has increased marginally as compared with the previous round of survey for both three-month ahead period and one-year ahead period. The RBI would want to contain inflation expectations before lowering its guard against inflation.

Along with the inflation numbers, the factory output numbers at 2.5 percent in September from 0.4 percent in August gives a promising picture on growth recovery.

If growth sustains and retail inflation, mainly food inflation, sustains its declining trend for another few months, the central bank may loosen its purse strings by April.

Any rate cut prior to that would be a surprise.