Will food inflation deter RBI from a rate cut needed for growth?
It is now a well established fact that the Indian economy is in the grip of a slowdown and needs policy support for accelerating the sluggish growth rate. Data released by the Central Statistics Office (CSO) last week show GDP growth at 6.8% in 2018-19 was the slowest in five years and it fell to 5.8% in the March quarter, lowest in 20 quarters since June 2014. Modi government 2.0 , therefore, has its task cut out on the economic front. Apart from some tough maneuvering in a tight fiscal situation to step up public spending, the government is also widely expected to push the Reserve Bank Of India (RBI) to cut interest rates in its Monetary Policy review this week. If a rate cut does happen, this would unleash much-needed liquidity in the system and spur consumption led buying, goes conventional wisdom.
‘Accommodative policy stance’
Many brokerages and policy commentators believe the RBI will toe the government’s line and adopt an ‘accommodative’ policy stance while announcing a rate cut. There have been difference over whether the Central Bank will announce a 25 bps (100 bps is a percent) cut on Thursday, go for a deeper cut or retain its neutral stance and desist from any rate cut. Majority of analysts and brokerages seem to side with the 25 bps rate cut chorus, saying a benign inflation should aid RBI is deciding in favour of a rate cut. Only, food inflation has begun inching up and with predictions of a below-par Monsoon this year, this graph may move further northwards. Will rising food inflation deter the RBI, this remains to be seen.
Garima Kapoor and Jatan Gogri of Elara Capital said in a note that weak growth amid benign CPI inflation is expected to create room for the Monetary Policy Committee to cut the repo rate by 50-75bp through FY20, beginning in June 2019. CPI is expected to average 3.8-4.0% in FY20E. And Kruti Shah at brokerage Emkay Global said, “the slowdown perseverance is likely to exist in most of FY20. Limited space of government spending, which is the driving force of growth in the last couple of years, is likely to keep growth sluggish till Q3FY20.
In addition, the NBFC liquidity crisis if addressed immediately also might take a couple of quarters to perk up the demand conditions. In addition, the spillover impact of the trade protectionism measures could pose the risk of widening CAD and growth. Based on growth overall weakness, we expect core inflation to remain soft, which is likely to pave the way for the RBI to cut rates by 25 bps in its Jun’19 policy.”
So what about rising food inflation? Analysts at Care Ratings noted that price pressures have been emerging with the rise in food and fuel prices. At the same time, core inflation has been moving downwards, reflective of the demand scenario. “Although upside risk to inflation exists from the pattern of monsoons and global crude oil price movement, inflation is likely to remain in the target range of the RBI. We expect CPI inflation to average 4% and WPI inflation to average 4.5% in 2019-20.”
How grave is the food inflation scenario? Anagha Deodhar of ICICI Securities pointed out that the agriculture sector recorded its worst performance since Dec ember 2015 in the March quarter this year as real agriculture growth came in at -0.1%. “The agriculture sector is battling with issues like supply glut and low global food prices. The sector’s deflator turned positive after remaining in the negative zone for past two consecutive quarters, consistent with the recent bottoming out of food prices and shows that prices of agriculture products have started rising.”
In fact, agriculture sector’s growth declined consistently throughout the year– in the first quarter of 2018-19, it recorded healthy growth of 5.1% but this declined to 4.9% in Q2, 2.8% in Q3 and finally ended the year with -0.1% growth in Q4. Farmers are battling issues like supply glut and low global food prices. Moreover, scanty rainfall in key foodgrain producing states like Maharashtra, Gujrat, Karnataka, Rajasthan, Andhra Pradesh, Tamil Nadu and Telangana led to less-than-satisfactory Rabi production, Deoghar added. All this means food inflation has risen and could rise further.
Analysts at Kotak Institutional Equities said that CPI inflation inched marginally higher to 2.92% in April against 2.86% in March. On a sequential basis, CPI inflation hardened by 0.5% month on month (0.4% in March), led primarily by 1% month on month increase in food prices (1.1% yoy as against 0.3% in March). While prices of fruits, vegetables, cereals and pulses have continued to firm up, prices of eggs and spices have posted sequential declines. “High frequency data suggest that food prices have sustained their upward momentum in May. Fuel and light inflation hardened by 2.6% (2.3% in March) on account of higher oil prices. We expect CPI inflation to average 3.8% in FY2020.”
As the RBI Monetary Policy Committee meets for three days starting today, it will surely weigh the benefits of a rate cut against its own inflation red flags. ends