beyondbrics

The Indian economy got a bit of good news Monday when headline inflation for the month of December fell sharply to a 24-month low of 7.47 per cent year-on-year, down from 9.11 per cent in November.

But a closer look reveals a correction based almost solely on a drop in the price of vegetables and shows that price pressure continues on manufactured products, even as fears grow about another severe depreciation of the rupee if the eurozone crisis deepens.

Because of its big food component, the decrease doesn’t necessarily have a lot to do with  the Reserve Bank of India’s 13 interest rate hikes since March 2010. But economists said the bank’s hawkish strategy did seem to have kept inflation from getting further out of control. Monday’s data could allow the bank to begin cutting rates sooner than expected.

In the year to December prices of vegetables, potatoes and onions plunged by 34.2 per cent, 35.5 per cent, and 60.5 per cent, respectively, according to data released by the ministry of commerce & industry. The price of manufactured goods, which make up around two-thirds of the index, grew by 7.41 per cent.

“Vegetables [were] the supply element of December 2010 as well – so there’s a big base effect that definitely played out which brought inflation down,” Indranil Pan, chief economist at Kotak Mahindra bank, told beyondbrics. “So in terms of quality of the drop, it might not be in line with what the RBI might be happy about if they were going to reverse their interest rate cycle” right away.

Indeed, the consensus view is still that the RBI will begin loosening monetary policy only in April, the first month of the Indian fiscal year, when inflation is expected fall to between 6.5 and 7 per cent.

As beyondbrics reported, better than expected industrial production figures for November, when output grew by 5.9 per cent, and and December’s PMI of 54.2 both support the case for no cut before April.

But Anubhuti Sahay, economist at Standard Chartered, said the RBI could consider cutting the cash reserve ratio at its monthly policy meeting next week to inject needed liquidity into the market. She said it may even consider reversing rates sooner if GDP growth figures for the quarter ending in December – expected within the next few weeks – show strong signs of a slowdown.

“We could see RBI cutting rates sooner if GDP growth slows down very, very sharply,” she said. “Then they need to shift focus on to growth [rather] than inflation.”

Moody’s Analytics stuck its neck out and called for a cut this month. It wrote to investors:

Today’s result alters our interest rate outlook slightly. We were honing in on a March rate cut but this latest inflation cooling may give the RBI sufficient reason to move before then. The Indian economy is slowing sharply and with inflation coming off its peaks, there’s no reason for the RBI to continue sitting on their hands. Look for an initial rate cut in February.

Related reading

Indian inflation falls to two-year low, FT
India inflation: better, but not great, beyondbrics
Food subsidy bill to test India’s finances, FT