Inflationary challenge not yet over; RBI can cut rates in FY17


It is difficult to cut rates when RBI is conscious of inflationary challenges.

Rupee, Indian Economy, India Rating, Union Budget, Fiscal Policy, Track2Media ResearchIndia Ratings and Research (Ind-Ra) expects average wholesale price index (WPI) to rise by 2.7% and Consumer price index (CPI) to rise by an average of 4.9% in FY17. Notwithstanding the benign retail and wholesale price forecast for FY17, Ind-Ra believes the inflationary challenge is far from over as food prices have more than often triggered surprises.

Ind-Ra’s Report ‘Economy to Expand, But Fiscal Slippage Likely in FY 17’ ‘published on 18 January projects benign retail and wholesale price forecast for FY17.

India is not alone and Emerging markets are also likely to see retail prices rise close to 6% in 2016 and 2017 as per the International Monetary Fund (IMF) projection that consumer prices in emerging markets will rise by 5.6% in 2016 and 5.9% in 2017.

This is also broadly in line with the Ind-Ra view on retail inflation in India which is likely to rise by an average of 4.9% in FY17. The IMF’s projection of a decline in commodity prices – oil prices by 17.6% & non fuel prices by 9.5% in 2016 is likely to keep the fuel and power component of wholesale prices in India down even in FY17.

Ind-Ra thus expects the average WPI to rise by 2.7% in FY17. Despite the expectation that prices remain under control in FY17, Ind-Ra believes the inflationary challenge is far from over as food prices have often in the past triggered surprises. The food related headwinds have been a mixture of structural and cyclical factors.

The structural issues plaguing Indian agriculture lately are i) stagnation in productivity, ii) rising cost of cultivation, iii) changing food consumption pattern, and iv) exploitation of supply shocks by intermediaries.

The government has made several attempts in the FY15 and FY16 union budget to address some of the structural/supply-side issues facing agriculture. An ambitious ‘Soil Health Card Scheme’ has been launched to improve soil fertility on a sustainable basis.

An agri-tech infrastructure fund, a technology driven protein revolution in the country, a price stabilisation fund, and Prime Minister’s irrigation scheme with a special focus on micro-irrigation and watershed development are at various stages of implementation.

An allocation of INR250bn has been made to the Rural Infrastructure Development Fund set up in National Bank for Agriculture and Rural Development (‘IND AAA’/Stable) to augment rural infrastructure. Also the target for the fund for FY16 has been increased to INR8,500bn, to improve the amount of agricultural credit to farmers.

Similarly, INR50bn has been allocated to upgrade/create warehouse infrastructure to strengthen the agricultural supply chain. A national market for agricultural commodities is also in the offing by overhauling the Agricultural Produce Marketing Committee Act in consultation with the state governments.

Ind-Ra believes these are important measures and if implemented appropriately will have a positive impact over the medium- to long-run. In the interim, however, the government will have to keep food inflation under check by keeping a close eye on agricultural output and its prices through market intelligence and intervention.

The government has succeeded in keeping in check the prices of cereals so far this fiscal due to the i) efficient food management, through the timely release of food stocks, ii) limited increase in agricultural support prices and iii) lower international food prices discouraging exports. The two food items that have spoiled the party lately are onion and pulses.

Although the WPI based price is still showing deflation, it has been declining since August 2015. It is likely to turn into inflation during 4QFY16 due to the rapidly inching up of prices of food and non-food articles.

Also, the progress of rabi sowing is not encouraging after the adverse impact of monsoons on the kharif output. As on 23rd December 2015, the total area sown under rabi crops stood at 52m hectares, lower than the same period in 2014. Ind-Ra therefore believes that seasonal/cyclical headwinds in combination with structural issues remain a threat for food prices even in the foreseeable future.

Similar to WPI inflation, the key driver of the Consumer price index (CPI), RBI’s nominal anchor, is food inflation. Having nearly 46% weight in CPI, food and beverage inflation jumped to 6.3% in December 2015 from 2.9% in August 2015.

However, Ind-Ra expects the CPI inflation to decline to around 5.8% in January 2016, RBI’s revised target. Although by calling the 50bp repo rate cut, in its fourth bi-monthly review on 29 September 2015, a frontloaded policy action, RBI has nearly shut the door on further rate cuts in FY16, RBI’s policy stance is likely to be accommodative in the near term. If conditions permit, Ind-Ra expects a 25-50bp cut in the repo rate during FY17.

By: Dr Devendra Pant, Chief Economist, India Ratings & Research


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