During the current financial year, industrial growth has languished at 0.4 per cent year-on-year. Persistent inflation and high current account and fiscal deficits have influenced monetary policy to reduce 50 basis points (bps) in the repo rate, 25 bps in the cash reserve ratio (CRR) and one per cent in the statutory liquidity ratio (SLR), while the limit of export credit refinance was increased from 15 per cent to 50 per cent.
In our view, with monsoon rains at eight per cent below the long period average, a decline in output of various crops as indicated by the First Advance Estimates, combined with higher minimum support prices, would keep prices of cereals, pulses and edible oils firm. Given that food items account for nearly 50 per cent of the consumer price index, we expect inflationary expectations to remain firm in the near term.
The diesel price hike and cap on the number of subsidised LPG cylinders are welcome measures, which would rebalance aggregate demand and partly ease concerns of the twin deficits. These measures would contain the subsidy bill, as well as the extent of the slippage relative to the budgeted level of the fiscal deficit. Also, higher prices may dampen demand for diesel and LPG to some extent, benefiting the trade deficit.
However, the pickup in core inflation in the second quarter, despite concerns regarding the strength of consumer demand, suggests the diesel price hike would be passed-through to prices of manufactured products. To an extent, the impact of the latter on core inflation could be partly absorbed if the rupee remains at current levels.
Overall, the inflation trajectory would be critically impacted by the crude oil prices and the rupee. At present, we expect headline inflation to exceed eight per cent in the third quarter, before easing in the fourth quarter. The stickiness in headline and core inflation may prompt the Reserve Bank of India to maintain the policy rate in the upcoming policy review. However, in light of the seasonal pick-up in credit demand, RBI might consider reducing the CRR by 25-50 bps to support activity. With headline inflation expected to average 7.5-7.7 per cent in the current year, the space available for further monetary easing is likely to be limited to around 50 bps over the remainder of 2012-13.
The author is MD & CEO, ICRA Ltd
