Soft inflation, IIP drop may induce Dec rate-cute: Experts

India's wholesale price index (WPI) rose a slower-than-expected 7.45 percent in October from a year earlier, government data showed on Wednesday. Sonal Varma of Nomura and Brinda Jagirdar of SBI Securities explain to CNBC-TV18 that a moderation in inflation and the drop in IIP data might force the RBI to initiate a rate-cut in December.

Below is an edited transcript of the analysis on CNBC-TV18. Q: Would you say that the increase in October WPI is still remarkably good enough for the Reserve Bank to rethink its decision to cut rates? Varma: This is definitely good news and should not be completely ignored. The momentum on inflation has clearly moderated due to the appreciation of the rupee which is lowering of costs, especially on non-food primary articles, which in turn has reduced prices and thereby easing core inflation.  To an extent, there was some hint of this in the manufacturing PMI which indicated a fall in input and output price indices to a two-year low.
So I think momentum has eased off and it is important to consider what this means in estimate a forward-looking trajectory because the Reserve Bank’s own trajectory had inflation peaking at around 8 percent in December and then falling to about 7.5 percent by March. Of course between now and March, there will be a lot of triggers. But the data available so far suggests that inflation will be in the 7-7.5 percent range by March.
But I think, more importantly, core inflation will come in at 5.2 percent and we do think that there will be further moderation in core inflation in the next couple of months as well. So the RBI's guidance clearly remains. There was some doubt on whether there would be a rate cut in January or a March and this data surely cements the case for a rate cut in January. Q:  How worried would you be about that revision of August inflation to 8 percent considering that it was possibly one of the highest levels seen in this entire calendar year for WPI? Jagirdar: Certainly, this time the data that has come in as a pleasant surprise and the moderation in all the three major sub-groups is very good along with softening of core inflation. But the upward revision in August data is certainly worrying and there could be some revision in the data for September and October.
So my worry is that while food inflation has softened and manufacturing month-on -month is down a bit, fuel inflation is still in double-digits and that it remain at that level is some concern. I am not too sure whether all the increase in the fuel prices has actually been factored into the data.
The softening is not only coming in from food inflation, but also from global commodity prices and the rupee remaining strong. If the data is not revised, there is a clear downward trajectory which brings forward the possibility of a RBI rate cut.
Continued softening of inflation along with the sharp slowdown in IIP could perhaps get the RBI to act in December itself. Q: But do you fear an October revision at all?
Varma: I would not expect such a steep revision in October. The factors that lead to the upward revision in August were an increase in core inflation by about 10 bps, marginally higher food inflation and substantially higher revision of mineral prices within the primary.
So even the September reading is going to see a significant upward revision. But the October estimate has already taken into account higher mineral prices and I don’t it will be significantly revised. But there would be some revision, so this 7.45 percent headline WPI would be somewhere between 7.50 percent - 7.70 percent by the time we get the final forecast. Q: Growth has been crying out for help, now that inflation has shown its hand and the momentum has clearly slipped. Would you really rule out a December rate-cut? Varma: One can’t rule out a December rate-cut. I think the argument for no rate cut in December was that the headline inflation would remain fairly elevated till December and the RBI will review its inflation and growth forecast in January and therefore it has given guidance for the current first quarter.
But given these significant changes in the inflation trajectory, I do think it is significant unless there is a shock going forward. The risk to the 7.5 percent- inflation forecast by RBI could be either balanced or have some upside or rather downside risk because the March estimate could be in the 7-7.5 percent range.
_PAGEBREAK_
There are arguments for pre-poning the rate cut, particularly based on core inflation. The reading of 5.2 percent in October would mean that in the coming months, core inflation could fall below 5 percent. The other arguments are economic in nature. So whether the RBI chooses to actually do it or not we will obviously have to see.
I think given that the RBI has guided for a rate cut in the January-March quarter, our bias would be that the RBI would perhaps wait for the January policy. But there are enough arguments already- the arguments that hold true for the January policy actually will hold true even in December. Q: The CPI is still hovering at 10 percent mark vis-à-vis the WPI which is around 7.45 percent. What do you think the RBI is going to do in terms of according more weight to the CPI data vis-a-vis the WPI? Jagirdar: Clearly, the CPI at the 10-percent mark is high and is not showing any distinct signs of softening. So that is one concern which will weigh on the RBI when it looks at inflation. The WPI is a source of comfort as the softening is clear. The trend of continued core inflation softening is visible and that will bring down the WPI inflation as we go towards March.
So on the inflation front there is some comfort for the RBI and it will not look now only at inflation because I think the balance is clearly shifting towards growth. So that is what will weigh on the RBI. Though the CPI data remains high, the softening in food prices will perhaps have a moderating impact given the high weightage of food in the CPI index.
Overall, the chances of a rate-cut have increased and perhaps the RBI could act in December. The growth situation is really quite worrying and if there is no investment now, I think we will have missed the cycle for the next one-or-two years. Q: With the rupee depreciating and no ease in the pressure of the current account deficit, does the RBI have any elbow room and will you be revising your current account deficit estimate? Varma: Not just the current account deficit, the telecom spectrum auction also has been pretty bad. So the fiscal side is also not looking very pretty. And we need to take this fact into account that both the twin deficits are actually worsening in the big picture perspective. There is some room to ease policy rates and RBI will use those available windows to ease policy rates which we think will open up in first half of 2013. So we are building in 50 bps of rate cuts in first half of 2013.
But the big picture view is that there are still a lot of macro-economic imbalances and therefore one should not extrapolate to say that this is the beginning of an aggressive easing cycle. It is going to be a very slow, shallow easing cycle and RBI will opportunistically look for windows.
And, in particular, the concerns regarding the current account deficit are on the increase in the light of negative IIP growth. So per se domestic demand is very weak. Why is the current account deficit actually getting worse? It could partly be blamed on weak export demand, partly on seasonal demand because gold imports do tend to pick up in October before Diwali season.
But even after excluding these items, there is a pickup in import growth.
So our conclusion is that there is some amount of import substitution because domestically inflation is high, so cost of production is also high. And there are a lot of supply-side constraints. So firms that are not producing domestically are actually importing and that is why you are seeing this odd combination of weak domestic growth and a very high current account deficit.
So in this macro perspective, there is not much space for easing and this has to be always kept in mind not withstanding the small windows of easing that we will be utilised. Q: What is your current account fiscal deficit target now? Varma: I have not revised it. My target for fiscal deficit is at 5.8 percent and the current account deficit is 3.8 percent. Based on the data released in the last four days, the fiscal slippage could be an additional 20 basis point over my estimates and the current account deficit versus the 3.8 percent that I have budgeted, the shows that it will be as high as in FY12 - 4.2 percent of GDP. Jagirdar: I certainly think there will be some slippage in the fiscal deficit, but I am not so pessimistic. I think it will be closer to 5.5 percent because I still haven’t seen everything pan out. Yes, the spectrum auction has been a big disappointment but it remains to be seen how the government plans to fill this big hole in revenue. But I still think that it would be closer to 5.5 percent and we expect the year to close with a current account deficit of around 3.6 percent. Q: What are you expecting for Q2FY13 GDP and what is your estimate with regards to growth for the entire fiscal? Ranjarajan estimated the GDP to possibly stabilise at 5.5 to 6 percent. Would you adhere to that range and do you have any estimates? Varma: My estimate would actually be at the lower end of the range and we have recently revised our growth forecast. My GDP forecast is at 5.5 percent for FY13 and based on the IIP data, and the loss in kharif production, I estimate, for the Q2FY13 September quarter, a GDP of around 5.4 percent. Globally there is no sign of a pick up and agriculture itself is going to be weak. So, overall, there is no big pick-up in growth this fiscal year. Jagirdar: The weakness is mainly due to manufacturing and though there may be a slight pick up in agriculture, we would tend to bring our overall growth forecast from 6 percent to about 5.8 percent.