CPI will undershoot January target by big margin
With August CPI coming in at 3.7%, on top of a sharp decline in July CPI – it fell from 5.4% in June to 3.7% in July – the case for a Reserve Bank of India (RBI) rate cut has become even stronger. According to JPMorgan analysis, inflation momentum – seasonally adjusted quarterly annualized momentum – is down from 6.6% in June to 4.9% in July and a mere 2.7% in August. As a result, the RBI’s January target of a 6% CPI is almost certain to undershoot by 50-75bps – to the extent RBI is data driven, it is almost certain there will be a rate cut later this month, whether by 25bps or 50bps remains to be seen. Given the certainty of a drought, the question is whether fruits and vegetables inflation will soar and, if so, to what extent low global prices will dampen it. While every drought does not necessarily translate to higher fruits/vegetable inflation – it depends on how severe the drought is and in which regions – the government has the option of lowering wheat/rice prices through open-market sales (cereals have a 9.7% weight in CPI) and oil/fat prices can be lowered through imports.
Indeed, while many talk of green shoots in the economy to argue against the urgent need for a rate cut, this may be premature – though, it can also be argued that the newly-appearing green shoots need the kind of nurturing a rate cut can provide. It is true IIP grew 4.2% in July, but a detailed look indicates the picture is mixed – while capital goods were unexpectedly up sharply at 10.6%, core sector growth all but collapsed to 1.1%. Consumer durables rose 11.4% in July – to be expected given that July 2014 growth was minus 20.4% — thanks to the strong auto sales numbers for July when passenger cars rose 17.5%, two-wheelers 15.4% and M&HCVs 29.5%. But July passenger car sales were buoyed by a weak year-ago performance last year in July and M&HCVs had actually contracted in July 2014. While car sales slowed to a mere 6.1% in August, M&HCV sales grew a handsome 35.4% in August — and there was no adverse base effect in this case. But if durables growth suggests the return of consumer demand, why are FMCG sales doing so poorly, at minus 4.6% in July? As the confusing GDP data showed – the economy is slowing based on GDP data but growing based on GVA data – the economy is both growing as well as stagnating, depending upon the data being seen.
The other issue raised, in the context of a rate cut, is that RBI can ill afford to cut rates at a time when the US Fed may be raising its rates and, as a result, capital could flow out of countries like India. India’s macros – inflation, current account deficit, forex reserves – are a lot better than they were when talk of the taper first began, but past experience shows that even countries with better macros get hit when the direction of global flows change. But India has to deal with this at some point, whether now or 3 months later – indeed, as RBI Governor Rajan has pointed out, excess global liquidity has its own harmful consequences, so it is better that the US starts rolling back these measures, though slowly so as to minimize the volatility. RBI’s focus should be on stimulating India’s growth and not just worrying about trying to minimize the fallout of the Fed’s rate hike – and, in any case, if there is going to be an outflow of FII funds as a result, it won’t be slowed by India not cutting its rates.