India’s inflation fell below the stubborn 7 percent level in July taking economists by surprise, but the performance may be a one-off as core inflation actually went up, analysts warned.
The wholesale inflation figure was 6.87 percent in July, down from June’s 7.25 percent and against expectations of analysts polled by Reuters of a rise to 7.37 percent.
“At the first glance it’s a fantastic number,” Siddhartha Sanyal, director and chief India economist at Barclays Capital, told Emerging Markets, pointing out that it was “the first sub-7 percent number since November 2009.”
But he said the figure raised some questions as “there is a very unusual lowering of the fuel price index despite a rise in global energy prices” and the core inflation number, which had softened in previous months, “this time went up.”
The data showed fuel and food inflation eased in July while non-food manufacturing prices picked up.
The Reserve Bank of India has kept its repo rate on hold at 8 percent despite calls from the government for it to lower the rate to boost sluggish economic growth. July’s inflation figure does nothing to change that, Andrew Kenningham, senior global economist at Capital Economics told Emerging Markets.
The RBI “won’t be complacent about the outlook for inflation,” as the very bad monsoon this year will likely mean that food prices will increase, he explained.
Other factors that could push up inflation in the short-term but beneficial in the longer term, would be steps taken by new Finance Minister Palaniappan Chidambaram to reduce the budget deficit and restore investor confidence.
“The government ought to raise its administered fuel prices, particularly diesel,” Kenningham said.
REFORMS NEEDED
Chidambaram has asked experts to come up with ways to reduce the subsidies component of the budget back to the 2 percent of gross domestic product stipulated in the April budget rather than the estimated 3 percent currently, and measures are likely to be announced in September, he added.
“They haven’t taken any measures at all since April. The government has been doing little and hoping that circumstances will improve,” Kenningham said.
Industrial output was slightly lower in the second quarter from the same 2011 period, figures released last week showed, prompting Kenningham to say that India “is now suffering from stagflation.” Exports fell by 2.9 percent in the same period.
RBI Governor Duvvuri Subbarao has repeatedly warned the government to deal with reforms to boost economic growth rather than rely on the central bank and no later than Monday reiterated his stance that inflation was uncomfortably high.
Analysts do not expect the central bank to cut its interest rates in September but going forward some of them see the RBI forced to move as growth is likely to slow down even more.
“We expect a very significant RBI cut, we think growth is really suffering,” Barclays Capital’s Sanyal said. Barclays Capital expects the RBI to reduce interest rates by one full percentage point by the end of March 2013.
“The timing of such cuts will depend critically on the trajectory of headline inflation in the next 3-4 months, which will, in turn, depend quite a lot on food inflation,” he wrote in a market note. “Given the RBI's repeated inflation-fighting rhetoric, delays in further cuts to the RBI's headline policy rate cannot be ruled out. However, in that eventuality, rate cuts could be sharper in the latter half of the year.”
Capital Economics’ Kenningham sees the RBI cutting the repo rate by a maximum of half a percentage point by the end of the year, when he sees wholesale inflation at around 7 percent, industrial output flat and economic growth slowing.
Analysts see growth picking up in India when stalled reforms – such as liberalizing foreign investors’ access to the retail, insurance and airline sectors, cutting fuel subsidies and reducing corruption – are implemented in earnest. But, they say, with elections due in May 2014, the window of opportunity is closing fast.