Anticipated CPI inflation trajectory supports case for repo rate cut

The prints for CPI inflation, which is the nominal anchor for monetary policy, released subsequent to the last policy review, have been muted at 3.7 per cent each for July-August 2015. Despite the deteriorating monsoon dynamics, the sub- three per cent food inflation in the last two months is a source of respite, even though it has benefited from a favourable base effect.

Healthy groundwater levels owing to heavy pre-monsoon showers appear to have largely shielded foodgrain and oilseed crops from the worsening deficit in monsoon rainfall post July 2015, as revealed by the first advance estimates of crop prod-uction. While high inflation related to pulses and onions are a source of distress for households, the arrival of import shipments would help douse price pressures over the next two months. Moreover, the reduction in domestic fuel prices has dampened CPI inflation and misgivings regarding the inflationary impact of the revised service tax rate appear unfounded. 

Receding concerns related to kharif output and benign global commodity and food prices have tempered the risks related to the inflation trajectory, despite elevated inflationary expectations of households and the depreciation of the rupee. Post the waning of the favourable base effect from September 2015, Icra expects CPI inflation to print in the range of 4.0-5.5 per cent during the remainder of FY16 and substantially undershoot the Central Bank's projection for January 2016. Accordingly, we believe that adequate room exists for further easing, without resurrecting the debate about the relevance of WPI or CPI as the appropriate metric for monetary policy in India.

While a pickup in domestic economic activity has started to emerge in certain sectors, it is yet to become widespread. More, the Federal Reserve Bank's recent decision to hold rates has eased concerns regarding a hastening of FII outflows from Indian assets in the immediate term. However, progress on other important factors emphasised by the Reserve Bank of India (RBI), such as unclogging of supply side bottlenecks and transmission of past rate cuts by banks, remains mixed.

Nevertheless, in our view, there is a high likelihood of a 25 bps cut in the repo rate in the upcoming policy review.

The author is managing director & Group chief executive officer at Icra. Views are personal.