C’mon RBI Guv, Data Says You Can Reduce Interest Rates

Several factors like easing of inflation coupled with benign food prices might compel RBI to cut interest rates.

Reserve Bank of India governor Raghuram Rajan cannot ask for better conditions to further ease key interest rates and thus lower borrowing costs for companies and individuals, particularly since his monetary stance is guided by economic data. Inflation has eased further and there are more signs of growth momentum improving and consumer demand reviving.

Most importantly, inflation has further eased and there are indications that inflation will stay benign for months to come. The wholesale price index (WPI) continued to be in the negative territory for the ninth month, declining 4.1% in July 2015, on a year-on-year basis.

The consumer price index (CPI), an indicator that the RBI refers to for resetting interest rates, unexpectedly slowed in July 2015 to 3.8%, from a year ago. Significantly, food inflation index, a sub-index of CPI, too decelerated, rising just 2.2% in the same month. The CPI reading is the lowest on record since the new index was launched in January 2012.

Favourable Conditions

Decline in inflation caused by imports is the chief reason for easing of prices in the economy. India has benefited from the fall of petroleum crude oil prices from about $120 a barrel last year to about $50 dollars currently. The impact of that fall is most visible in the WPI. It is less visible in the CPI, which captures retail level prices, because higher excise duty imposed by the union government on both petrol and diesel meant retail prices did not fall as much as global prices of the two motor fuels.

Other commodities like metals and ores too have turned cheaper globally over the past few months, mostly due to slowing of the Chinese economy, and that too has helped bring down the level of inflation in India.

Food prices, with the exception of pulses and some vegetables such as onions, are relatively benign now. Better than expected monsoons and willingness of the government to act against hoarding and shortages is likely to keep food prices in check in the months ahead. In any case, high interest rates do not bring down food prices.

All Eyes on Rajan

• As inflation eases further, pressure builds on Rajan to further cut interest rates
• Favourable conditions abound with food prices being relatively benign for now
• India Inc worried about decline in WPI which in turn may impact their profitability

Economy Back On Tracks

Manufacturing activity is showing signs of revival, as the index of industrial production (IIP) and purchasing managers’ index (PMI), a leading indicator of economic activity, show. The IIP rose at its fastest in four months in June at 3.8%, from a year ago.

The PMI for manufacturing rose to a six-month high in July and that for services rose for the first time in three months. Manufacturing sectors are reporting improved order flows from the domestic as well as export markets and services reported a modest pick-up, purchasing managers’ told the monthly survey.

Ripple Effect

Buoyancy in indirect tax collections too indicates a revival in the organised sector, a point often emphasised by chief economic adviser Arvind Subramaniam. Total indirect tax collections in the four months of the fiscal year to July were 32.6% higher, compared to a year ago.

A part of that increase is largely due to the increase in excise duty on petrol and diesel, the largest contributor to government revenues, and partly due to an increase in the service tax rate from 12.36% to 14% with effect from June. The 6% depreciation of the rupee between April and July 2015 helped increase customs duty collections.

However, tax revenues rose notwithstanding the tax rate increase. According to the finance ministry, stripped of all additional revenue measures, indirect tax collections rose by 14.6% in April-July 2015 compared to the same period a year ago.

The continuous decline in the WPI is a worrying trend for companies. As industry bodies point out it could lead to loss of pricing power for companies and that could lead to erosion of their profitability. For the moment, lower prices of commodities have helped many companies improve their margins.

Lowering key policy rates such as repo rate will lower the cost of borrowings of banks from the Reserve Bank of India, and although the amount borrowed by commercial banks from the central bank is small, every drop in the cost of funds will aid lowering of lending rates.

(The writer is a Delhi-based senior journalist)