CPI inflation falls to record levels, IIP at 3-month low: Will RBI cut rates?

Pressure mounts on central bank to cut rates; food deflation persists amid farmer distress

Growth in industrial production fell to a three-month low in May while consumer price index (CPI)-based inflation declined below a stipulated floor of 2 per cent in June, providing the Reserve Bank of India leeway to cut the policy interest rate in August. Pulled down by capital goods, consumer durables and manufacturing, and mining, the index of industrial production expanded 1.7 per cent in May, lower than the revised 2.8 per cent rate in April. CPI inflation was down to a record low of 1.5 per cent in June from 2.2 per cent in the previous month.

Food items continued to witness deflation amid farmers distress in various parts of the country. The data came when the kharif sowing season is progressing smoothly with even pulses showing a rise in acreage.

Economists expect CPI inflation to remain lower than the mandated 2 per cent in July.

“Clearly, this low number and what it implies about underlying price pressures, as well as the latest IIP data just released, is something that all policy makers will reflect upon very carefully,” said Arvind Subramanian, chief economic adviser in the finance ministry. He said CPI inflation reflected consolidation of macro-economic stability. “The last time we saw such inflation, according to a slightly different CPI (IW), was in 1999, and before that in 1978,” he said.

The CEA said the forthcoming Economic Survey, to be authored by him, will fully elaborate a paradigm shift in the inflationary process to low levels. “This low, heartening number is consistent with our analysis for some time now,” he said. The shift of inflation to low levels has been missed by all “reflected in the large, one-sided, and systematic inflation forecast errors that have been made”, the chief economic advisor added.

In the past, Subramanian had criticised RBI for making errors in inflation forecasting and not cutting the policy rate.

ICRA’s principal economist Aditi Nayar felt the balance was tilted towards a 25 basis point cut in the repo rate. “Some members may choose to focus on the expected rise in CPI inflation post August rather than the lower-than-expected prints over the last several months,” she said.

Nayar saw a low likelihood of rate cuts in the second half of the financial year with a reversal of the favourable base effect likely to push CPI inflation above 4 per cent. On the low IIP numbers, India Ratings Chief Economist Devendra Pant said, “It appears that demonetisation woes persist. India Ratings believes the lagged effect of demonetisation will remain at least till June.” 

In terms of broad sectors, electricity generation expanded 8.7 per cent in May against 5.4 per cent in April. Both manufacturing and mining performed dismally. While capital goods contracted by 3.9 per cent in May after rising in April, consumer durables fell for the sixth consecutive month at 4.5 per cent in May. The new category of infrastructure and construction goods was almost flat, growing 0.1 per cent. Food prices continued to deflate at 2.1 per cent in June after a 1 per cent deflation in the previous month. An over 20 per cent deflation in pulses prices and more than 16 per cent in vegetables led the fall.

However, vegetables price deflation was likely to reduce next month due to the monsoon, Pant said. Inflation in services, barring personal care and effects, declined in June from May. 

However, Pant said this was not a good sign for the economy with lack of both manufactured and services demand. 

The increase in house rent allowance is likely to affect CPI inflation, but its effect will be staggered.