IIP, Inflation: Good enough reason for a rate cut?

Latest economic data has raised expectations that the Reserve Bank of India (RBI) may cut key rates in the policy review on January 29.

Led by a moderation in the prices of fuel and manufactured goods, the headline inflation slowed to its lowest level in three years. The wholesale price index (WPI), the main inflation indicator, came in at 7.18% for the month of December 2012 – lower than 7.4% rise estimated by analysts.

Meanwhile, as per data released last week, the industrial output contracted to a four-month low of 0.1% in November due to poor performance of manufacturing and mining sectors and decline in production of capital goods.

All this has raised expectations that the Reserve Bank of India (RBI) may slash key rates in the policy review on January 29.

But with the central bank oblige and is there enough reason for a rate cut?

“Although the WPI inflation has eased on monthly basis, the food inflation which is the major component of WPI remains a concern for the economy,” states a report from India Forex Advisors.

Says Robert Prior-Wandesforde, Head of Economics Research for Southeast Asia and India, Credit Suisse, “The RBI may slash rates probably by 50 basis points (bps) to 7.5% in the January review.”

“We believe the central bank’s failure to act on October 30 probably reflected a fear that the government could fall when parliament returned in November, while it may also have wanted to see whether the February budget contains the promised consolidation measures,” he adds.

Notes Sonal Varma, economist, Nomura, “In our view, underlying inflation expectations remain sticky as evidenced by high CPI readings. Yet, with core WPI inflation clearly moderating – indicative of weak demand-side pressures, we stick to our view that the RBI is likely to cut the repo rate by 25 bps on January 29. However, we do not see this as the start of a long rate cut cycle and expect a total of only 50 bps cut in H1 as we expect inflationary pressures to re-emerge in H2.”

However, on the other hand, Shubhada Rao, chief economist at YES Bank feels that the data presents a mixed picture. “It’s a mixed picture with CPI tending higher. However, if we look at the numbers closely, the core CPI (month-on-month) has been at a nine-month low at 0.51%. Likewise, WPI was a fairly positive number though marginally lower than our expectation. The core WPI was at 4.2%, which was lower than the preceding month. The developments do suggest that the inflation is probably now going to provide some comfort for the RBI to begin easing rates.”

Upasna Bhardwaj, an economist at ING Vysya Bank expects a 25 bps cut in March 2013 if the Government continues its effort to reign in fiscal deficit at 5.3%. Even if the figure is around 5.5%, markets will take that as a positive, she suggests.

MARKET REACTIONS

So, how are the markets players interpreting these numbers? Is it a good time to start accumulating interest rate sensitive stocks?

"With weak economic activity and WPI easing to 7.18%, it seems that the RBI will trim rates by 25 basis points in Jan 29. The RBI The will watch the Budget, assess the fiscal situation, and if convinced, another 25-50 bps cut is likely by March," says Phani Sekhar, Fund Manager - PMS, Angel Broking.

Kishore Ostwal, CMD of CNI Research, however, is cautious in his approach. “I will adopt wait and watch policy. Inflation numbers easing to 7.18% does not indicate that the RBI will reduce rates. I expect that the Central Bank will maintain its hawkish stance in the next policy review meeting. Increase in fuel prices and train fares could prevent inflation from moderating in the near term,” he says.

Among the rate sensitive stocks, while Shekhar of Angel is bullish on private sector banks like HDFC Bank, ICICI Bank and Axis Bank; Ostwal prefers Karnataka Bank and DLF.