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Inflation rises, but analysts expect RBI to cut interest rates anyway

It’s bad news on the face of it, but a closer look at the wholesale price inflation (WPI) numbers released today reveals that things are not as bad as they appear, and chances of an interest rate cut by RBI are not totally absent.

Government numbers released today revealed that the rate of price increase in the wholesale market accelerated in February compared to the decelerating trend seen in the previous six months.

While prices were rising at a rate of over 8 percent as of September last year, the rate of increase had fallen to 6.62 percent in January. (This is not to say that prices fell, but that they were rising more slowly.)

India has an unofficial target of keeping price rise under 5% a year, and higher price increases make the finance ministry and the Reserve Bank of India uncomfortable. High price inflation has resulted in lending rates (bank interest rates) nearly doubling in the last 4 years.

For example, RBI’s official lending rate, at which it offers money to commercial banks, was 4.75% in April 2009, and was hiked to 8.5% by late 2011. It was only slightly relaxed in April 2012 when the Reserve Bank cut repo rate to 8%.

Meanwhile growth has suffered, even dipping into negative territory for manufactured items in some months last year. There is widespread expectation that the RBI will lower interest rate next week as part of its monetary policy announcements.

However, some of those expectations have been hit a blow by the rise in WPI reported today. The consumer price index had already shown an increase in February to 10.91% compared to 10.79% for January. Now, the WPI has reported an increase from 6.62% in January to 6.84% in February.

However, a deeper look at the numbers reveals that nearly all of it was caused by a single factor — a steep hike in the price of petrol, LPG and diesel.

Diesel has a weightage of 4.67% in the overall WPI, petrol 1.09% and LPG 0.91% — in all adding up to 6.67% of the total index. And the numbers here are telling:

Against a price rise of 4.3% in LPG in January, the price increase in February was a steep 26.2%. Similarly, against a year-year-year increase of 15% in diesel in January, the inflation in February was 19.2%. Petrol prices increased by 6.25% in February, compared to 3.8% in January.

Overall, the price of all ‘fuel and power’ items (which have a combined weight of nearly 15% of the total WPI) have gone up by 10.5% in February compared to a 7.1% rise seen in January.

The accelerated rise of fuel prices offset the slower rise in prices of manufactured items, which account for nearly 65% of the total weight of the wholesale price index. Manufactured item price inflation dipped to 4.51% in February compared to 4.81% in January and 6.47% in September. Of course, prices are still going up, but their rate of increase is now within the targeted 5% range. (see chart below)

The remaining category in the WPI — primary and food items (comprising the remaining 20%) — also showed a slight deceleration. However, it must be noted that price increase in primary items is very much out of the comfort zone.

Primary items are a sensitive category as a rise in prices of items like grains, vegetables, fruits, milk, oil seeds etc. hit the low-income groups harder than other groups. Low income groups spend a large part of their income on these items and higher prices in this category reduce their spending power much more than similar increases in other areas such durables.

Prices of primary items (75% of which are food items) increased by 9.7% in February, much more than the targeted 5%. However, their prices were increasing by more than 10% in the preceding two months. An area of concern would be food prices.

Food prices increased by 11.38% in February, largely due to a 19.2% increase in the price of cereals. In comparison, 3 to 6 months ago, food prices were increasing only by about 7-8%.

Wheat prices rose 21.6% in February while rice prices were up 18.8% — hitting the common man particularly hard. Potato and onion prices were up 46% and 154% respectively. Non-veg items, which have been driving price inflation recently, also rose 12.85% in February — largely unchanged from the trend for the previous six months.

Among major manufactured items, textile prices were up about 5%, metal item prices up about 1.85% and chemical prices up 5%.

Despite all this, analysts continue to expect an easing of interest rates by in the upcoming policy review by the RBI. As a result, the share price of ICICI Bank went up 2.2% today. It had fallen nearly 3% yesterday on fears that WPI numbers would be too high, and interest rates would not be reduced. High interest rates have affected loan issue by banks and growth in companies.

“The headline inflation print has inched upwards largely driven by the rise in fuel price index as it accelerated to 10.5% yoy (rise of 3.0% mom),” pointed out Bhupali Gursale, economist at Angel Broking.

“On a positive note, inflation in manufactured products has decelerated further and core inflation has receded to 3.8% reflecting the decline in commodity prices as well as weak pricing power.

“This should give the RBI some elbow room to ease rates in the March 19 policy as monetary policy stance has turned more growth-supportive. We expect a 25 bp cut in the repo rate by the RBI in the forthcoming policy review, but rate cuts going forward are likely to be limited by still-prevalent upside risks to inflation and the widening current account deficit,” she said.

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