Core CPI worrisome; see 25 bps repo rate cut: JP Morgan

In an interview to CNBC-TV18, Sajjid Chinoy, economist, JP Morgan gives his review on the December inflation figures.  "The wholesale price index (WPI) a positive surprise. I think there is now evidence over the last three months that as the economy has slowed below potential, we have opened up a pretty large negative output gap that has caused the momentum of core inflation to fall," he says.

Chinoy, however, is worried about the core consumer price index (CPI). "The CPI number was no surprise. There is a negative base and an unfavourable base effect that came into play so the month-on-month increase is only 0.2 percent for the CPI. The worrying part about the CPI is that core CPI is still above 8 percent this month. This would the seventh consecutive month that core CPI has not fallen," he opines.

Below is the edited transcript of Chinoy's interview to CNBC-TV18.

Q: The consumer price index (CPI) is 7.18 percent vis-à-vis 10.56 percent. What is your thought with regards to all the macro data points that we seen since Friday? How exactly is the RBI going to react according to you?

A: The wholesale price index (WPI) a positive surprise. I think there is now evidence over the last three months that as the economy has slowed below potential, we have opened up a pretty large negative output gap that has caused the momentum of core inflation to fall. I will simply point out that the year-on-year number today was 4.24 percent but the month-on-month seasonally adjusted number actually rose by about 0.4. So, there is little bit of an uptick compared to the last two months but nevertheless a good number. That is good news.

The CPI number was no surprise. There is a negative base and an unfavourable base effect that came into play so the month-on-month increase is only 0.2 percent for the CPI. The worrying part about the CPI is that core CPI is still above 8 percent this month. This would the seventh consecutive month that core CPI has not fallen. At some levels it is understandable when you have cost pushing inflation, you find that WPI falls much sooner than CPI.

This does open up space for the RBI to cut by 25 basis points in January but there are a lot of other mitigating factors. We have got a large current account, we have got a large fiscal deficit, so those will weight on the Central Bank. Cyclically, there is evidence here that the economy has bottomed. Atleast industrial production has bottomed in the last couple of months. In the first and second quarter of 2013 – if you see, consumption picking up, exports picking up, rural demand picking up because of a strong winter crop, then this negative output gap may close and the moderation inflation will only last till March-April probably. So, any space for monetary easing will be in the first quarter and front loaded.

Q: Is there an elbow room at all for cash reserve ratio (CRR) at this juncture? Or will they wait for that kind of Liquidity adjustment facility (LAF) borrowing?

A: The preference over the last couple of months has been to try and save your gun powder. There was a case for CRR cut in December. Liquidity was extremely tight then and the RBI had decided to let it go. Their preference will be to do open market operations (OMO) and inject liquidity that way. There is still possibility that you could have global shocks in 2013. There is debt limit fight. You could have temporary bouts of risk aversion, liquidity could dry up and they would want to save CRR for those opportunities. The preference would be that more for open market operations than to  tactically go for a blunt instrument like the CRR.

Q: What do you think the Governor's stance is going to be like?

A: I think it is going to be a balanced stance. There are two ways to look at today’s number. Yes, it is better than what we have had three months ago, it is better than expectations. But from an absolute level, we are still running WPI inflation above 7 percent, their medium-term target for core inflation is between 3.5-4 percent and this number is still at 4.2.

One way to look at this is to say, in the best of all scenarios where the rupee has stabilised over the last three months, we are running a pretty large negative output gap. Over the last quarter, growth has slowed and bottomed and still the bottom for core inflation is 4.2 percent. In the next six months, as the economy picks up, the pressure on core is going to get worse not better. I think the governor will exercise abundant caution.

Look at the example of 2012. Risk was taken and there was a 50 bps cut early in the year and then things didn’t pan out quite the way expected. Given the current account, given the fiscal deficit, my sense is 25 bps in January and then a period of wait and see of the Budget because, that is really the key event from then on.

Q: What are you expecting on January 29, how many basis points by way of cut and which instrument?

A: I am expecting a 25 bps for repo rate and nothing for CRR.