Theres no doubt about the Reserve Bank of Indias (RBI) desire to cut interest rates to support the slowing economy: RBI deputy governor Subir Gokarn said as much two weeks ago. But its ability to do so is another matter, given the countrys persistent inflation problem over the last year.
So every inflation release is a key data point right now and Januarys wholesale price index (WPI) print was definitely encouraging. (Unlike most economies, WPI is the key inflation benchmark in India, because of problems with the countrys consumer price index series.) WPI inflation in last month was 6.55% year-on-year, down significantly from 9.5% in November and at its lowest for more than two years.
The speed of the turnaround has not been quite as great as that implies, since base effects and food prices accounted for most of the fall. As Capital Economics puts it:
|Two factors explain why the annual inflation rate has fallen so steeply. Firstly, large price rises in December and January the previous year have dropped out of the annual comparison. Secondly, food prices have been declining as a result of a good harvest: vegetable prices alone have fallen by more than 30% in the past two months, and overall food price inflation is now near zero.|
And policymakers have been careful to maintain a slightly hawkish tone: Finance minister Pranab Mukherjee said the rate was still unacceptably high. Still, with underlying trends looking favourable over the last three months, prices of non-food manufactured goods increased at an annualised rate of less than 5%, says Capital Economics a first rate cut looks possible within the next three months.
That should be good news for an economy that is showing the combined effects of the RBIs 13 rate hikes this cycle, a slowing global economy, a eurozone crisis-induced nervousness in global markets about providing financing to emerging market companies and poor sentiment over corruption scandals and the slow pace of reforms. GDP growth in the July-September quarter was 6.9% year-on-year and the fourth quarter figure due out soon may well be significantly lower. So hints that cuts are on the way arent coming a moment too soon.
That said, inflation is not the central banks only headache: the countrys large current account deficit and resulting dependence on foreign investment inflows is also a persistent worry. Some analysts, notably at Nomura, have argued that in the event of capital flight from emerging markets, India might even need to consider hiking the benchmark rate to shore up the weak rupee and staunch outflows, as we discussed last week. So while the RBIs bias is clearly towards cutting rates as soon as possible by far the most likely outcome its still conceivable that another twist in the eurozone crisis might yet hold it back.