June Inflation At 7.25% Gives Less Scope For Rate Cut

The June inflation numbers are out now and they show a declining trend in the headline inflation. For the June 2012, the Inflation grew by 7.25% compared to 7.55% in May 2012 indicating some decline. The decline in the index of fuel and power articles by 0.4% helped partially the inflation to cool off. The food articles inflation grew by 1.4% while non food items inflation grew by 2.6% in June 2012.

The markets initially gave a green signal to the inflation numbers and then immediately surrendered by taking over half a per cent decline by closing. So what triggered this? Well the government release shows the upward revision in the April inflation data from 7.23% to 7.50%. High revision would mean that the inflation still remains sticky and may not permit RBI to cut the rates. Also the May IIP numbers at 2.4% shows some growth in the manufacturing segment though that of lower quantum. The markets also took hints form the earlier comments of RBI that the inflation is a concern for economy and economic growth can wait for some time.  The markets under these circumstances see inflation high enough not to give any scope to the RBI to cut the key policy rates.

The current scenario provokes differential thoughts in a way that there is no unanimous voice in the markets whether RBI will go for the rate cut or not. There are few things that weigh in the side of the rate cut while some are against.

Currently the economic growth is on the top of the agenda for the top central banks in the world. Banks in the major countries have taken initiative in their quest to ease the economic growth. This is evident from the recent cuts that China went ahead twice in the last one month while ECB also cut the rates to take them to the record low. The Chinese premier has went one step ahead and hinted towards monetary easing to boast the growth if required. Bank of England has given 80 billion pounds of cheap loans under the ‘funding for lending’ scheme.

The story in India is same as the economic growth has taken a back step. The IIP data in last few months has been very disappointing. The April IIP figures shows that there was contraction in the economy. Overall during the April to May 2012 the growth was -0.8% against 6.2% in the same period last fiscal which is an alarming signal. Under such circumstances there are few who believe that there would be a rate cut, if not Repo then at least a CRR reduction could also be a possible outcome.

There are also reasons to believe that RBI may not follow the actions of its peers. The inflation above 7% is out of comfort zone of RBI. The June 2012 inflation figure, though second lowest in last 30 months, is the fastest in the BRIC countries.

Indian economy at present needs growth and some action is expected from the government. There are indications that the government may go with some reformist measures after the presidential election on 19^th July. As the country is witnessing lower growth, this may provide much required impetus to the industries, especially to the sectors like insurance, Retail, Aviation etc. If such things happen then RBI may not be required to cut the rates and may keep the Status Quo. Besides upward revision of the April 2012 inflation to 7.50% should not be ignored as it indicates sustained high levels of inflation.

Under these conditions it is very difficult to clearly forecast what RBI will do. The Brent Crude again touching the three dollar mark will increase the fuel prices. Rupee still continues to trade at historic low making all imports costlier and widening our trade balances. There are no clear signs of adequate monsoon this year which would keep the food and vegetable prices higher. Last but not the least recent Power tariffs hiked by many states also increase the probability of the Inflationary curve to move in northward direction.

Given the reasons we at Dalal Street Investment Journal believe that RBI would once again keep the Status Quo and would leave the rates unchanged for some time.