'Inflation worrying; chance of max 50bps rate cut in FY13'

India's wholesale price index (WPI) rose a faster-than-expected 7.81 percent in September from a year ago period, largely driven by higher fuel prices. Sajjid Z Chinoy of JP Morgan believes the situation is certainly worrying and since food inflation has not contributed much to this figure, it is hard to see inflation easing anytime soon. Going forward, he feels if the rupee stabilizes around the 52-53 per dollar mark, it could provide some relief in the coming months.

Gaurav Kapur of Royal Bank of Scotland is of the view that an inflation figure close to 8 percent is purely due to a high base effect and the situation remains worrisome. "As base effect wears off in November-December, it can even touch 8.5 percent by December-January. Even though on the core side we have seen numbers stabilizing, I don't think headline will give solace anytime soon," explained Kapur.
Looking at the recent inflation data, Chinoy expects a CRR cut instead of a repo rate cut from the RBI on October 30. However, Kapur does not agree to this and feels, a 25 bps rate cut would be a better option when compared to a CRR cut. In fact, if there is any rate cut, the central bank has space to cut only 25-50 bps in the rest of FY13, added both the experts. Also read: See inflation around 7% by March 2013: C Rangarajan Growth to turn around in six month: Ahluwalia Here is the edited transcript of the interview on CNBC-TV18. Q: Doesn't 7.81 percent worry you, more importantly I don’t have the core inflation yet but manufactured products inflation is up 6.26 percent YoY and 0.5 percent higher month on month? Chinoy: That's certainly worrying. Even if you account for the fact that about 25 basis points of this is due to diesel price hike, you are still looking at about 7.55-7.6 percent. So, inflation has got very sticky around that 7.5% mark and refuses to come down.
I think what makes this even worst is that it is not food inflation, food prices have only gone up about 0.5% seasonally adjusted month on month an this is not driven primarily by food. I think this reinforces what we have been saying for months that until you have more capacity creation, it’s going to be very hard to see a secular downturn in core and headline inflation and unfortunately that has been playing out. Q: How exactly would you read the 7.81 percent September WPI figure and what would be the trajectory going forward according to you? Kapur: You have seen a number lower than 8 percent purely on the basis of a high base effect. A fairly strong base effect going into this month, almost 90 odd bps, so this number is clearly very worrying. The past revisions are largely on account of electricity prices.
Going forward, things clearly do not look good on the inflation front. We have been expecting inflation to inch up over 8 percent, especially as base effect wears off in November-December and it can even touch 8.5 percent by December-January. Even though on the core side we have seen numbers stabilizing, I don't think headline will give solace anytime soon.
_PAGEBREAK_ Q: Manufactured products coming in at 0.5 percent. In August it was a very ugly increase of 0.8 percent. That is why the core inflation had also gone up to 5.56 percent, I am as yet unable to calculate the core on the basis of that, but it is a little mellower if you only looked at the MoM inflation. In August, MoM increase in manufactured products was 0.8 percent. Now it is coming in at 0.5 percent. Would you count that as a relief? Chinoy: There is a lot of volatility on a MoM basis and I would be very weary to make generalizations based on one month's number. What's worrying is the phenomenon that if you look at the three month by three month seasonally adjusted annualized basis, core inflation was running at less than 2 percent four months ago.
That number in terms of momentum has stepped up to over 6 percent. I think that is the concern. Let us be fair. There are a couple of factors here that could work in its favour going forward. Commodities have not really been set on fire by QE3. So those expectations will be more muted than we thought and the rupee has begun to appreciate. Let us not underestimate the influence of that.
There is a very strong correlation between the momentum of core inflation and the rupee. To the extent that the rupee stabilizes at the 52-53 mark as opposed to 56-57, that could give us some relief on core in the months ahead, but this is not a good number in any case. Q: How exactly do you think the RBI is going to read this inflation figure along with the IIP figure of around 2.7% on October 30 and we also have the yields hardening around 8.17 at this point in time, how would you read what the RBI could possibly do at the end of the month? Chinoy: Let's not forget we had a CPI number on Friday. All India CPI was 9.7%, core CPI is stuck at 8.2% and there is no relief on the inflation front across the board. I think they are caught between a rock in a hard place. On the one hand you have seen a lot of action by the government, one can question whether those actions will have any impact in the near term but, the fact is what the RBI has been asking for it since last year and it has come true in the last six weeks.
There are indications that the government will come forward with more fiscal consolidation plans in the coming weeks. Perhaps, strategically there was a case for some reciprocity for the RBI to say the government acted and therefore, we should take a calculated risk, a gamble which is what the government has been saying but, with numbers like these the credibility of the Reserve Bank is on the line.
I won't be surprised if you get some compromise like a CRR cut as being a gesture of reciprocity without signalling any easing in light of these numbers. Q: With the little bit of data I have given you I know you cannot calculate the core, but are you getting the feeling that the Reserve Bank will have an argument that manufactured products index is coming down? Kapur: I don't think the number is below 5 percent even then. Q: It is not below 5 percent, but it is below 5.56 percent. Kapur: Still it is much higher than the long-term average of 4 percent and that is something which RBI has been continuously pointing out. The case for a rate cut can always be made. I agree with you.
I don't think there is a case for a CRR cut. If RBI has to make a small gesture, they should actually do a 25 bps repo rate cut because by providing more liquidity you are running the danger of shifting the corridor from 8 to 7 percent over a period of time. Perhaps, if they were to do something as a reciprocal measure to what the government has done and as a preemptive measure, clearly considering that inflation is not within their comfort, I think they would look to do a 25 bps rate cut which does not dilute their ability to fight inflation which clearly has supply side pressures driving it up.
At the same time, it does provide some degree of softening to rates. On the other side, on the growth side, investment activity has bottomed out. I think all these measures which the government has taken over a period of time will start showing up in investment activity picking up gradually.
I think RBI can take a calculated risk, even though these numbers do not suggest that going by their stance in the past they should be doing anything. But, as they surprised in April I think even now that element of surprise can be used and you can actually see a 25 bps rate cut.
_PAGEBREAK_ Q: What is the liquidity scenario right now in terms of the bond markets and would you think a 25 bps on the CRR would be justified? Chinoy: I think the core number today will matter because the headline numbers got a fair amount of diesel in it, about 20-25 basis points. The headline number is going to get worse over the next couple of months because diesel will be priced in and so will be the core number. The second round impact of the diesel price hike will also show up in manufacturing prices.
I think the cleanest way would be to look at the momentum of core. If we do find it significantly below 5.5% today, then there is a case for something to be done. If you assume there are no more open market operations between now and December for example, because currency in circulation goes up quite sharply during the festival season, liquidity will still stay in the deficit mode of about Rs 60,000-70,000 crore.
Even if you do a 25 basis points CRR cut, that just adds a small amount which is not going to take the liquidity into surplus. But, I think there could be a case here like April since the government has acted and the RBI may say, we are going to front load any kind of monetary easing whether it is CRR or whether it is a repo rate cut now under the expectation that this momentum at the government continues.
With a clear knowledge that the space for any easing is still limited, even if there is 25 or 50 basis points of cuts through the next six months, that’s all there is space for because it's unlikely in the next few months we are going to see inflation come down anywhere close to 7% or below 7%. Q: If I have to poll you on October FY13 expectations what would your reply be? Kapur: That is a difficult one; there is a small probability of 25 basis point rate cut. Let me qualify by saying it is a small probability. The core inflation has actually gone up and these numbers don’t give any comfort to RBI. The only thing they would look to do is a reciprocal gesture to the government considering all these steps which have been taken since mid-September. Q: To extend that point forward, besides the October 30 policy in particular, how exactly do you expect the RBI to move for the remaining part of the fiscal? Kapur: They don't have much space to do monetary easing. If they do something now then another 25 basis points over the span of this fiscal year, but clearly there is no room beyond a total of 50 basis points cut, at least in this fiscal.
Unless something happens and you see inflation numbers coming down, which looks very unlikely, I am expecting inflation numbers to start looking more ugly as we get into October-December. But, I think they would have to at some stage start balancing it out. The room for rate cut is clearly very limited. Q: What is the final expectation on October 30? Chinoy: The core inflation for this month is 5.6 percent after accounting for everything and that leaves you in a grey zone. If it was 5.1 or 5.2 percent the likelihood of a rate cut would have been much higher. If you are approaching 6 percent then it would almost definitely be ruled out.
At 5.6 percent you are in a very grey zone. My sense is that given the extent to which the government has put itself at political risk to push these measures through, the RBI would perhaps take a calibrated risk in the October review. It is a quarterly review where they are more prone to taking these bigger decisions. 
My sense is you will probably get a 25 basis point repo rate with a clear indication that this is being done not because it is justified by inflation dynamics but because the government has acted and the medium-term demand-supply outlook is a little less unfavourable and that they will specify that the space for more easing is very limited.
A repo rate cut will be symbolic, if they want transmission to be enhanced and lending rates to go down which is really what the ministry of finance is pushing for and then don't rule out some sort of a CRR cut.
_PAGEBREAK_ Q: What would be the inflation trajectory now? Chinoy: I think it is actually going to get worse as was pointed out. You are going to see the full impact of the diesel prices show up next month. You will then see the second round impacts through core inflation going up.
We actually see it going quite significantly above 8 percent in January or February. The only solace here is that if the rupee stays at 52 that will provide some inflation relief. But by March 2013, we don’t see this come anywhere below 7 percent or so. Hence, a sobering perspective over the next 5 or 6 months. Q: What would be the inflation trajectory now? Kapur: I clearly see it going above 8 percent by November-December itself. Besides the impact of diesel price hikes, you would also see the impact of weaker monsoon on food prices and to the extent rupee remains stable, I think it will not add to the problem.
By and large, I think even non-food manufactured product inflation has remained fairly sticky. That will continue to feed through and you will see numbers gradually as base effect wears off. You will see numbers moving over 8 percent, perhaps even touching 8.5 percent as we get into Jan-Feb.