With core inflation down to 3.8%, the first sub-4% number in just under 3 years, it’s a near-certainty that RBI will cut the repo rate 25 bps on Tuesday, and perhaps by a similar amount later in the year in a bid to stimulate growth now that inflation looks under control. There is none of the usual base effects—February 2012 WPI was higher than that of January 2012—and inflation is very clearly trending down. If wholesale inflation remained at around 10% levels for each month of FY11 and eased to the 7.5% level by the last quarter of FY12, this came down further to around 7.2% in the third quarter of FY13 and has been sub-7% since January 2013. If WPI inflation is at 6.84% and not lower, this is because of the poor management of the food economy. The policy of not unloading buffer stocks that are 3 times what is required has kept cereals inflation at 18-19% levels over the last 3 months and primary articles inflation at near double-digit levels, though they fell just below this in February. Nor was it just food. Fuel inflation jumped 3.4 percentage points (ppt) in February because of the fuel deregulation and added another 0.5 ppt to the overall February WPI of 6.8%. Indeed, the fact that manufacturing inflation continues to fall, to 4.5% in February, this is because industry has collapsed—despite the 2.4% rise in IIP in February, April-February FY13 growth has just been 1% versus 3.4% in the same period in FY12. Not surprisingly, Crisil points out, while the input price index for industrial goods has risen from 100 in April 2011 to 112 in February 2013, the output price index rose to only 107.
What is more encouraging is the changed stance of RBI. In his IG Patel memorial lecture at the London School of Economics (LSE) on Wednesday, RBI Governor D Subbarao spoke of India’s macro-economic challenges (see the Reflect page for a summary). In the 3 years prior to the crisis, he said, investments rising added to productive capacity and kept core inflation in check. In the post-crisis period, in contrast, investments slowed to half the pre-crisis rate while consumption remained at pre-crisis levels (until last year) due to government welfare programmes and so stoked inflation. More interestingly, while outlining the criticism of cutting rates in the face of a high current account deficit—this raises aggregate demand and worsens CAD and the lower interest rate differential makes a country unattractive to foreign flows—Subbarao countered both arguments. When growth was slow, he said, a rate cut wouldn’t add to demand and, in any case, lower inflation would make India’s exports more competitive. And while debt flows may slow with a rate cut, he argued, equity flows would rise.
While high CPI, at 10.9%, continues to remain stubborn, part of the reason is the vastly higher weights—cereals have a 3.37% weight in WPI vs 14.6% in CPI, for instance. There is also the fact that while WPI immediately takes into account any rise or fall in input prices, this takes 6-9 months to get factored into CPI through prices of manufactured products in retail markets. While RBI may not look at CPI data while deciding on Tuesday, the government needs to pay attention since this signals large supply-side distortions—high CPI will also mean lower household savings in financial instruments and greater amounts in gold.