Stretched rupee may dull rate cut hopes

Stretched rupee may dull rate cut hopes

Stretched rupee may dull rate cut hopes

India’s consumer inflation likely eased for the third straight month in May, but remained high enough to be a headache for the RBI, which is under pressure to cut rates again next week after headline wholesale inflation cooled.

Consumer inflation likely eased to 9.05 per cent in May from 9.39 per cent in April, a Reuters’ poll of economists showed.

The Reserve Bank of India (RBI) Governor Duvvuri Subbarao said recently that there were upside risks to retail inflation, comments which markets interpreted as lessening the chance of a fourth straight rate cut at the bank’s policy meeting on Monday.

“Retail inflation, as measured by consumer price index is still high,” Subbarao said on May 30.

Policymakers are also worried that a sharp downward trend in the rupee, which hit a record low of 58.98 to the US dollar recently, could lead to rise in prices of imported items such as edible oil and build up inflationary expectations in the economy.

“The RBI has always had to consider a large number of factors in deciding its policy. It doesn’t look at one number to decide policy. Obviously, the exchange rate will be an input,” the Finance Ministry’s Chief Economic Adviser Raghuram Rajan said recently.
New data, old problems

The focus on consumer prices is new for India. Until recently, the wholesale price index was the only game in town for policymakers, because of inadequate data collection from rural areas. The government began to release comprehensive CPI inflation data only last year.

Wholesale inflation eased to 4.89 per cent in April, the lowest level in three years, but the drop is not being felt by consumers — retail inflation has remained close to or above double-digits for more than a year.

That is the highest among the BRICS group of economies including Brazil, Russia, China and South Africa.

“I would predict inflation (CPI) between 8.5 and 9 per cent in the next couple of months,” said N R Bhanumurthy, professor at the National Institute of Public Finance and Policy.He noted the weak rupee could push up inflation expectations in spite of hopes that food prices will soften as a result of monsoon rains.

The RBI now says it will increasingly monitor prices at a retail level, partly because the wide gap has made the consumer index difficult to ignore. The bank is expected to one day make the consumer index its main gauge, like most other countries.

Prime Minister Manmohan Singh’s government has lost its majority in parliament and is limping towards elections due within a year. It is worried that rising food prices will dampen efforts to win back voters.

The RBI cut the interest rate last month for the third time since January to 7.25 per cent but said there was little room for further policy easing.

The government faces an uphill task to revive economic growth, which expanded at a decade low of 5 per cent in 2012-13 fiscal year ending March, hit by slowing investments, a widening current account deficit and the falling rupee.

Since September, it has taken steps to open up more sectors such as retail for foreign investors, and approved more infrastructure projects in a bid to spur growth and avoid a threatened credit downgrade to its sovereign debt.

On Tuesday, Rajan said the Finance Ministry will recommend to the cabinet that limits on foreign investment be raised in a number of industries.
Widening gap

Economists say CPI inflation is unlikely to decline soon because of the high weighting of food items in the index. Food items make up nearly 50 per cent of the CPI index, compared with just 14.3 per cent in the WPI index.

“CPI is unlikely to fall below 7 per cent for the next few months, and that is a very high level, considering the rise of prices of commodities like milk in the CPI index,” said a senior economist at the Ministry of Finance, who declined to be identified because of the sensitivity of the issue.

He said food prices could ease marginally with a normal rainfall and an improvement of cereal supplies in the market.

Prices of food items like eggs, fish, meat and cereals have gone up by nearly 15 per cent over the last one year, hitting poor households, which are crucial for the Congress party to win back power in Asia's third-largest economy.

The government wants to push through legislation to create a massive food welfare programme that would give cheaper grain to about two-thirds of 1.2 billion population.