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

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.

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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 priceinflation 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.