WPI at record low: RBI reducing rates will change nothing

With another data print suggesting easing of pricing pressure, Raghuram Rajan now has fewer excuses for not reducing interest rates. India's wholesale price index (WPI) fell at a faster pace to a negative 4.05% in July, the ninth straight quarter of a negative print. WPI has touched the lowest level in the last decade.

Analysts expected WPI to touch -2.76% as compared to -2.4% in June 2015 and -2.8% in July last year. Fuel prices fell by 12.81% and a fall in food prices by 1.16% brought headline inflation to a record low.

Retail inflation which till the month of June was diverging against the falling slope of WPI also dipped as per the recent numbers. Retail inflation fell to a record low of 3.78% in July as compared to 5.48% in the previous month.

In a report, Bank of America Merrill Lynch said the deflationary pressures are building even beyond base effects, and the CPI inflation is on track to RBI's under-6% January 2016 target.

With both the wholesale and retail numbers in the downward trend, market expectation has increased that RBI will have to reduce interest rates. Earlier in the week, a Finance Ministry official said high interest rates is hurting the economy. The official has been quoted as saying, "My view is that we are wrong in not lowering the interest rate and we are wrong in not letting the rupee depreciate. China is devaluating Yuan to boost their exports."

Indian exports have already been affected over the past few months on account of a global slowdown. China’s devaluation is expected to add further pressure on exports from India.

Lower inflation numbers also reflects lower demand in the country. Core inflation fell by -1.41% as compared to expectation of -1.1%. In order to revive growth, RBI will have to reduce rates and put pressure on banks to pass on the reduction. Of the 75 basis points reduction announced by the central bank this year, only 25 basis points have been passed on by a few banks, while many others have not even done that.

Though RBI has to face the pressure of reducing interest rates, it is the bankers who are playing spoilsport.

Public Sector Banks have been hiding behind an excuse of higher NPAs which is preventing them from passing on the rate cut. But there is no such pressure on private banks. Private sector players have a healthy balance sheet and largely cater to the retail segment. Because of their share of corporate loan of only about 24%, private players have not been as affected as public sector players due to the slowdown. Private players are shielding themselves behind public sector players and are using the opportunity to strengthen their profits.

If private players take the initiative in cutting interest rates, market pressure will work on public sector players to cut rates. Further, since private players are strong in retail segment, reducing interest rates will push up demand and help overall growth of the economy.

The central bank standing as a mute spectator even after announcing three interest rate reductions serves little purpose. Even if RBI reduces interest rates, there will be no impact on the economy if the banks do not pass it on.

The government and the central bank will have to devise a mechanism of enforcing interest rates reductions to make these transmissions meaningful.