Central bank to hold back for now

All too suddenly, retail inflation does not seem to be a problem, coming off from a high of 11.2 per cent in November 2013 to 5.5 per cent this October. This was almost the last bastion that needed to be broken, after India's macro had hugely transformed itself from a shaky zone to one poised for the next big leap forward. No doubt, the markets have started to price in a repo rate cut from the Reserve Bank of India (RBI) to support the positive sentiment.

The central bank might not be in any immediate position to deliver a rate cut, even as the first target of sub-eight per cent inflation for January 2015 is likely to be achieved. The critical issue is that most of the softening of inflation till now has been on cyclical factors - namely the global softening of oil and commodity prices and a late revival in the monsoons that saved us from the problem of food inflation in this financial year.

First, RBI will have to be confident that these cyclical conditions will sustain. Oil prices might reverse course if OPEC decides to cut production. The rupee had also been on a moderate depreciation course. Importantly, with the domestic supply-side dynamics not having eased in any way, RBI will remain cautious towards any demand pick-up and its implications on core inflation.

However, beyond doubt the softening pace of retail inflation has been much more than anticipated even by the central bank. This could put them in a more dovish corner as far as the domestic rate cycle is concerned. We think if the cyclical factors mentioned above sustained, RBI could ease its monetary policy around April 2015, after having also factored in the structure of the domestic Budget in end-February, 2015.

The author is chief economist, Kotak Mahindra Group