In continuation of the dismal trend of bad news after Tuesday’s flat IIP numbers, exports fell 4.1% in April (imports fell 7.4%, bringing relief to the deficit, but making it clear the economy's growth impulse remains very weak). This prompted Moody’s Analytics to join the downbeat chorus on the economy. Moody’s senior economist Glenn Levine said India was in “stagflation” and added that while the RBI couldn’t be too aggressive about cutting rates, “with the inflation numbers now being driven by supply-side factors, we think that the RBI could cut rates without it putting too much upward pressure on inflation”.
Even before that, though, Thursday’s sharp hike in minimum support prices (MSPs) of 14 agricultural goods is likely to put additional pressure on inflation, which will play a role in the RBI's decision-making. MSPs have been hiked by 15-16% for paddy, 30% for pulses like urad dal, 35% for oils like groundnut and sunflower oil, and 40-50% for coarse grains like jowar and ragi.
Not all economists agree on rate cuts. CLSA economist Rajeev Malik says, "I don't think this data, especially the revision, gives much of breathing space to the Reserve Bank of India to cut the repo rate, maybe the cash reserve ratio (by 25-50 basis points), but bear in mind that the RBI has indicated it is comfortable with liquidity."
While Nomurra's Sonal Varma says she expects a 25 bps rate cut, Deutsche Bank's chief economist Taimur Baig says while he thinks a rate cut is not the right thing to do, “we think the central bank will be pressured into doing this”.
Citibank economist Rohini Malkani said the WPI “complicates policy but odds of easing remain” – Citi has revised its rate call for 2012 to a further 50-75 bps of easing versus 25 bps earlier.
While the RBI will keep in mind the inflationary potential of the MSP hike, and a likely diesel one, what may prompt a rate cut on Monday is that the central bank's proxy for core inflation – 'manufactured non-food product inflation – came down to 4.9% in May, a bit lower than in April, and continued its secular decline from 8.4% in November.
Indeed, a deeper analysis of the inflation numbers makes it clear the problem remains with food products, and while keeping overall demand low will help rein in inflation, the real issue remains a supply-side one, requiring a totally different set of interventions like freeing up agricultural markets, increasing investments in agriculture, and so on.
While food inflation is back up at 10.74% for May compared with -0.68% in January, its contribution to the overall hike in WPI is also up sharply – from -1.8% in January to 24.9% in May. Manufacturing inflation, on the other hand, is down from 6.71% to 5.02% in the same period (it was 8.17% in November 2011). Core manufacturing inflation is down from 6.96% to 4.84% in the same period (it was 8.35% in November 2011). The share of manufacturing inflation in overall WPI growth is down from 56.7% in January to 39% in May.
Despite this, not everyone is convinced a rate cut will help. IIM-Bangalore economics professor Vivek Moorthy argues (on the Reflect page), as does Crisil, that a rate cut will not bring investments back on track since these are driven by other business conditions – Crisil talks of easing policy-related bottlenecks being more important than rate cuts. Axis Bank senior vice-president Saugata Bhattacharya, however, argued (“How much can RBI help spur growth?”, FE, June 14) that rate hikes in the last two years have raised interest costs by Rs 2.4 lakh crore for business – so even if a rate cut doesn't stimulate investment immediately, it will improve corporate balance sheets.