Price in a rate cut

With Jan WPI at 6.6%, a 25bps repo cut looks likely

After the poor industry and GDP data, the wholesale price inflation data comes as a pleasant surprise with headline inflation at an unexpected 6.6%—and this is when there’s no ‘base’ effect either. And manufactured non-food products inflation (RBI’s proxy for core inflation) has come down to 4.1%, almost bang on RBI’s stated comfort zone for this. The sharp slowing in the IIP—it contracted 0.6% in December, and April-December growth was just 0.7%, or less than a fifth that in the same period last year—makes it unlikely FY13 GDP will rise much beyond the 5% projected by the CSO in its advance estimates. And with GDP slowing, inflation has come off to under 7%, from around the 7.5% levels towards the end of FY12 and the average monthly 10% levels in FY11. Given the fragility of the current account deficit (CAD)—and RBI Governor’s statement that Q3 CAD would be worse than the Q2’s 5.4% of GDP—it seems unlikely that RBI would want to stimulate consumption too much either. Any worsening of the CAD, in turn, will put further pressure on inflation—around 60% of the WPI basket comprises tradeables and will, therefore, see greater inflation if the rupee depreciates further.

At the end of the day, however, the ball remains in the government’s court. High food inflation, especially of cereals like wheat and rice, is outside the purview of monetary policy, while the government has a lot more levers at its command. After contracting 1.7% in the April-January period in FY12, wheat prices rose 14.5% in the same period in FY13—with this happening when the Food Corporation of India has wheat coming out of its ears, it is not clear why the government has not dumped wheat stocks in the market. Interestingly, and this should provide some comfort to the government, despite the hike in diesel prices—and the promise of doing this every month—the overall fuel index slowed from 9.4% in December to 7.1% in January, thanks to inflation coming down in other fuels like naphtha and aviation turbine fuel that are sold at free-market prices. For April-January FY13, the fuel index rose 10.1% as compared to 13.9% in the same period in FY12. While a repo cut will undoubtedly stimulate consumption, its role in stimulating investment is less certain since most projects that have stalled—the value of stalled projects is up around 3 times since FY10—have done so for other reasons ranging from lack of environment clearances to even defence clearances. Apart from the functioning of the Cabinet Committee on Investments (CCI), investors will be looking to the Budget for their cues. That includes not just what the finance minister will do in terms of compressing expenditure but also what he does in terms of redressing the retrospective tax imposed by his predecessor as well as what is announced by way of the slew of transfer pricing adjustments that industry has been hit with.