Is the June inflation data enough to cut rates?

Wed, 16 Jul Pre-Open

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Recently, the government released inflation data for the month of June 2014. The numbers were quite encouraging. The wholesale inflation fell to 4 months low at 5.43% for month of June. Even the retail inflation eased to 7.31% for the said period.

Now, the next monetary policy review is scheduled on 5th Aug 2014 and given these encouraging inflation numbers, all eyes are on Dr Rajan's decision on policy rates.

So, will the RBI opt for a rate cut given that inflation data has been favourable?

For that to happen, it is becomes important to determine the reasons for the fall in inflation and the possible outlook. As per an article in the Economic Times, some part of this improvement is attributable to the new government's measures to control prices. The government has warned sellers against hoarding and has taken some punitive steps to keep the prices of staples like potatoes and onions under control. These steps are in line with government's target to ease inflation. Accordingly, even in the latest Budget, the finance Minister has allocated funds to ease inflationary pressures.

While the government continues to take various measures to tackle inflation, there remains the flip side as well. Below average monsoons continue to remain a challenge for the government. Further, the price control measures are more short term in nature and may be inadequate keeping in mind the dynamics of India's food market and lack of infrastructure. There still exists the wide gap between the demand and supply, lack of storages and irrigation facilities. These issues have led to the prices of various necessities soaring. Having said that, one of the various proposals put forth by the Finance Minister was to build and strengthen warehousing facilities in the country, which we think is a much welcome step. And could go a long way in easing India's food inflation woes, if executed well.

In the meanwhile though, the RBI could be reluctant to ease rates at this juncture given that poor monsoons might increase inflationary pressure in the economy. Not just that, for the RBI to cut rates, it will need to be convinced that the low inflation data is not a one-off. This means that there will need to be a sustained trend of lower inflation numbers in the coming quarters.

Further, in our view, the solution to bringing inflation down in the longer term lies not only in easing interest rates, but also in addressing the supply side bottlenecks. We have already seen the government announce some measures on this front. But now it needs to implement the same. Once it is successful in doing so, inflation is bound to reduce and this will pave the way for interest rates to come down as well.