The growth in Index of Industrial Production (IIP) for September at 2.5% was a positive surprise (SBI at 0.3%), even as CPI numbers for Oct’14 at 5.52% was largely in consonance with market expectations (SBI at 5.45%). Read Full Report: SBI Ecowrap
The bad news is that the growth in IIP may not be sustained, while the good news is that disinflationary trends seem to be well-entrenched. Our analysis shows that since Jan’14, the decline in CPI has been broad-based with food and service contributing to 79% and the rest (21%) through the benefits of benign global commodity prices.
Additionally, real rural wages that are supposed to have a direct causation with food prices have declined in current fiscal. The IIP growth pangs seem to suggest that while the infrastructure sectors are showing incipient signs of revival, the export-intensive sectors are showing clear signals of losing stem.
Consumer durables continue to show a deceleration. Even though inflation numbers are supposed to be below 7% in Mar’15, we continue to maintain that RBI will prefer to adopt a wait and watch approach before cutting rates.
In a developing country like India, we believe that information frictions typically result in household expectations of the price level being more sensitive to inflationary news than disinflationary news.
The intuition is that households respond more strongly to bad news and hence this asymmetry exists in survey data of household inflation expectations. Furthermore, disinflationary signals take longer to be incorporated into household beliefs and therefore demand-driven recessions are longer-lived than demand-driven booms, as is being currently witnessed.
Given this fact, the clamor for rate cut chorus will get louder with each passing day we maintain that RBI may go for the jugular in a decisive manner (50 basis point or so), but only after it is convinced that CPI downward trajectory is sustained and inflationary expectations are anchored decisively lower.
This may happen materially only in FY16. However, in an inflation targeting framework, with the Government having the goal independence (and RBI: instrument independence) is likely to set a CPI target more than 4% and this may then hasten the RBI action.
By Dr. Soumya Kanti Ghosh, Chief Economic Adviser & GM, Economic Research Department, SBI.