Theres no doubt about the Reserve Bank of Indias
(RBI) desire to cut interest rates to support the slowing
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
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
. 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%
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.