WPI, CPI fall guarantee a rate cut but govt shouldn't expect a big dose

Rate cut lobby has a reason to cheer. The decline in both the wholesale and retail inflation numbers in August should offer comfort to the Reserve Bank of India (RBI) to go for a quarter percentage rate cut in the repo rate on September 29 or even before that. [caption id=“attachment_2434130” align=“alignleft” width=“380”]  Reuters[/caption] The wholesale price Index (WPI) inflation remained in the negative territory for the 10th consecutive month at 4.95 percent, while the more crucial consumer price index (CPI) inflation also continued to decline, logging 3.66 percent compared with 3.69 percent in July. Also, the July number itself was revised to 3.69 percent from 3.78 percent. This somewhat guarantees a quarter percentage cut in the RBI’s key rate, also considering the fact that there is tremendous pressure on RBI governor Raghuram Rajan to cut rates and thus aid a faster economic recovery. Finance minister Arun Jaitley and the top economists in the government have been stepping up pressure on Rajan for steeper rate cut. Arvind Panagariya, vice-chairman of the NITI Aayog, has made a strong pitch for 50-100 bps cut in the RBI’s key rates. One bps is one hundredth of a percentage point. In a reccent interview to CNBC-TV18, Panagariya said time is ripe for a bigger rate cut. “We need a rate cut of 50-100 basis point (bps). I think time is ripe.” Besides, Panagariya, the government’s chief economic advisor Arvind Subramanian too have been making public comments on rate cut, citing higher interest. Given this, coupled with the incoming data points, one shouldn’t be surprised to see a 25-50 bps rate cut from the central bank before the year ends. But there are a few reasons why the central bank wouldn’t go for a steeper cut. One, inflation battle isn’t over yet. Food inflation remains sticky, even though the overall inflation seems to be inching downwards. Food inflation rose marginally to 2.20 percent from 2.15 percent in last month. There is a likelihood that food inflation may inch up even higher in a deficient monsoon scenario since major part of India still depends on rains for irrigation. According to government estimates, in the current year, the monsoons are likely to end up 12-14 percent deficient. The RBI would want to assess the full impact of a failed monsoon on prices of vegetables and essential items. Also, there is a possibility of retail inflation inching up from September when the benefit of base effect fades. The prices of essential items haven’t come down on the ground. For instance, wholesale onion prices grew 65.29 percent in August compared with last year, while pulses were costlier by 36.40 percent during the month. Second, the central bank would also want to watch the data on the widening difference between rural and urban inflation. The rural CPI inflation in August stood at 4.47 percent compared to 4.44 percent in July, while that in the urban areas, the figure was quoted at 2.67 percent in August compared with 2.94 percent, indicating pricing mismatch. Third, the central bank would want to wait and carefully look at the global scenario, especially the US Federal Reserve move, before making a significant policy move. A possible rate hike by the Fed in the near future and its impact on the global markets would be something that can make the central bank bit more cautious on a steeper rate cut. If the US Fed chooses to hike rates, emerging markets including India might witness high volatility and outbound capital flows. Fourth, the current growth concerns in the domestic market are attributed more to the structural issues in the economy than something that can be cured by a rate cut dose, which will only address the interest cost part. Governor Rajan had argued against the notion that the monetary policy can solve economic issues. A Firstpost analysis of 15 infrastructure companies showed that interest cost, as a percentage of total cost, constitutes only about 13 percent on an average. The government can act more to help these firms by fast-tracking reforms and clearance processes aiding faster project execution, while a reduction in the RBI’s key rates would only have a minimal impact. Fifth, interest rates in the money markets have already come down throughout this year after the RBI cut the repo rate by a cumulative 75 bps. This has benefited large, top-rated firms to raise funds through bond issuances. Banks, however, haven’t been able to pass on the full benefit of the rate cut since they are burdened with bad loans and do not want to risk their balance sheet further by pushing credit to struggling companies. The RBI wants more monetary transmission. Sixth, there is some sign of economic recovery beginning to take hold with the government starting to spend. The most encouraging aspect about the 4.2 percent jump in the Index of Industrial Production (IIP) in July is the primary trigger for this is a sharp rebound in capital goods segment. This trend, if it continues, gives a breathing space to the RBI to tread cautiously on the rate cut path, since it is till fighting inflation. The bottomline is: The available data so far indeed point towards a rate cut in the immediate future. But, the government shouldn’t expect the RBI to go for a bigger cut at this stage as price worries aren’t over yet. (Data support from Kishor Kadam)