Record Low Indian Inflation Adds Pressure for Patel Rate Cut

  • Plunging food prices, cash ban aftershocks triggered fall
  • Central bank says unclear whether effects are transitory

If India’s central bank wasn’t feeling the pressure to cut interest rates after last week’s imbroglio with the government, it may be now.

Consumer price inflation in the $2 trillion economy slid to new record low of 2.18 percent in May, figures showed Monday, below the 2.4 percent estimate in a Bloomberg survey of economists. The data come just five days after the Reserve Bank of India, led by Urjit Patel, refrained from cutting interest rates at its latest policy announcement, provoking a swift rebuke from Prime Minister Narendra Modi’s chief economic adviser.

"As inflation continues to remain lower than the RBI’s guidance, we expect the numbers to add to the pressure on the central bank to reduce rates," said Anjali Verma, Mumbai-based economist at PhillipCapital.

Asia’s third-largest economy is facing a slide in inflation amid a plunge in food prices, aftershocks from the government’s cash ban and a deceleration in growth to 6.1 percent, its weakest in two years. A glut of soured debt that that’s dried up credit demand to a 25-year low is also weighing on the economy.

At its interest rate announcement on June 7, the RBI said it’s unclear whether whether such forces are transitory. It kept its benchmark repurchase rate at 6.25 percent and maintained a neutral policy bias. It did however, pare its inflation forecast to 2 percent to 3.5 percent for the first half the fiscal year ending in March, down from a previous 4.5 percent estimate, opening the door to a rate cut, according to some analysts.

That didn’t appear to go far enough for government adviser Arvind Subramanian, who told a media briefing only hours after the decision that conditions warranted a substantial easing.

Read more: Divide Widens Between India’s Central Bank, Government on Rates

Now, the central bank is facing yet another drop in consumer price inflation. The dip to 2.18 percent followed a reading of 2.99 percent in April. Less than four years ago, Indian consumer price inflation stood at 11.5 percent. The RBI aims to keep inflation near 4 percent in the medium term.

Negative Territory

Anticipation of an interest rate cut has helped spur demand for Indian assets. Overseas holdings of rupee-denominated government and corporate debt rose 148 billion rupees ($2.3 billion) last week, the most in two months, after the RBI cut its inflation projections. Overseas funds bought a net $322 million of local shares the day after the policy announcement, the biggest inflow in almost three weeks, though they are still net sellers for the month.

A big drag on inflation has been the tumble in food prices, which has helped spur deadly protests by farmers. The country’s food inflation fell into negative territory, sliding to a drop of 1.05 percent from a 0.61 percent rise in April, data on Monday showed.

Prices of soybean, mustard and peanuts have dropped to a five-year low after output rebounded in 2016-17 on normal rains, following two years of drought. Wholesale prices of food grains including rice, wheat and pulses fell for four straight months through March and were about 10 percent lower compared with November, according to government data.

Structural, Temporary

With India poised for a normal monsoon -- so far it’s above normal -- low inflation will persist into the second half of the year, said Soumya Ghosh, group chief economic adviser at the State Bank of India. The weighted contribution of food inflation in the consumer price index has dropped to about 19 percent from 54 percent in April 2016, Ghosh said, and it’s not just good weather.

Structural changes have also played a part, he said. These have included government moves to restrict exports and curb stocks. A plan to implement a digital platform that will allow farmers to trade directly with suppliers is also underway.

Indranil Pan, chief economist at IDFC Bank Ltd., isn’t so sure India has vanquished food inflation. “The mean reversion of these food items will have to come at some point,” Pan said before the release. Arguing that food inflation will stay down is tantamount to saying rural income and demand will also continue to decline, he said.

The case for a rate cut at the next announcement in August isn’t 100 percent, he said. “I side with the RBI. It’s difficult to evaluate what’s structural and what’s temporary.”

GST Ahead

For its part, RBI said in its rate statement that figures on national income and industrial production suggest the effects of demonetization are specific and transient and that private consumption showed resilience. Indeed, the Central Statistics Office reported industrial production rose 3.1 percent in April, versus and estimate of 2.7 percent in a Bloomberg survey and a revised 3.8 percent in March.

The introduction of the goods and services tax also looms on July 1 along with salary increases for thousands of bureaucrats. The bank also said one of the reasons it remained on hold was that “premature action at this stage risks disruptive policy reversals later and a loss of credibility.”

If inflation keeps sliding, the search for credibility for this inflation-targeting central bank, may take on new meaning.

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