Inflation is under control, demand is very sluggish
The moderation in year-on-year consumer inflation to 4.9% in April, from 5.3% in March, offers the central bank a window to trim the repo rate by 25 basis points, from the current 7.5%, when it meets on June 2. The lower inflation, of course, is also driven by a base effect since CPI in April last year was at an elevated 8.5%; in the case of food items, it was 9.2% versus 5.1% in April 2015. While the end of the base effect and a poor monsoon could get inflation to climb again—and this could be one reason for RBI to pause on June 2—few economists are factoring inflation levels of more than 5.8% for FY16, the number the RBI has itself forecast—Citibank, though, has a 5% number. There are several reasons for the optimism.
For one, with global food prices staying soft, this puts a damper on local prices. Also, while vegetable inflation has risen due to unseasonal rains—it fell from 14.4% last year in April to minus 3.4% in December and then rose to 11.1% in March before slowing to 6.6% last month—this has been more than made up by the collapse in cereals inflation. Cereals have a 60% higher weight in the CPI than vegetables. Cereal inflation has been steadily collapsing, from 8.3% in April last year all the way down to 2.2% last month—this is driven by both softer global prices as well as the fact that, last year, the government had announced its intention to, over a period of time, sell 15 million tonnes of wheat and rice in the market; just a fifth of this has been sold so far, signalling the government still has a lot of room to depress prices further. Also, while rising crude oil prices—prices rose 40% since January—could upset inflation calculations, a lot depends on whether prices stay at around $70 or so. From 5.6% in April last year, fuel CPI fell to 3.7% in January and rose all the way up to 5.6% last month—in other words, with all fuels, apart from LPG and kerosene, at market prices anyway, global inflation is fully reflected.
RBI may still choose to pause and argue, apart from the need to get a better monsoon picture, banks need to first fully pass on repo cuts by it. The latter, however, is a meaningless argument since, by that logic, RBI should not raise rates unless banks hike their base rates accordingly—when RBI raised rates by 75 bps between September 2013 and January 2014, SBI raised its base rate by just 20 bps. What RBI needs to keep in mind, though, is that the economy is still very fragile. At 2.8% in FY15, industrial production is certainly better than FY14’s minus 0.1%, but it is very poor—indeed, March IIP was a mere 2.1% versus February’s 4.9%. While it is true interest rate cuts alone will not help get investment back on track, within the overall weak industrial production, it is consumer durables where demand has completely collapsed—production of durables fell 12.5% in FY15 on top of a 12.2% fall in FY14. While this is also driven by overall growth considerations, this demand is influenced the most by interest rate cuts. It would be decidedly odd if, with inflation under control and such poor demand, RBI didn’t cut rates on June 2.