CRISIL expects RBI to cut repo rate by 25 basis points

The Reserve Bank of India slated for Monetary Policy review on March 19

The wholesale price index (WPI)-based inflation rose to 6.84 per cent in February 2013 after falling to a three-year low of 6.62 per cent in January. However, the core inflation — an indicator of demand side pressures on prices — fell below the four per cent mark for the first time in 35 months, strengthening the case for a repo rate cut by the Reserve Bank of India (RBI) on March 19, says a report by CRISIL.

Repo is the rate at which the central bank lends money to other banks.   

Even though input prices have risen sharply due to a weak rupee and rising fuel costs, corporates have been unable to pass on the cost increases into output prices as demand has weakened significantly. This has resulted in a widening gap between input and output prices over the last two years, and reflects the limited pricing power of corporates in a slowing economy, says the report. This is also getting captured in the declining core inflation. In February 2013, core inflation fell to 3.8 per cent from 4.1 per cent in January.

The rise in inflation was driven by a sharp increase in fuel inflation as global crude oil prices rose to $116.7 per barrel in February while the rupee was 9.4 per cent weaker as compared to a year ago. Moreover, diesel prices were highly subsidised last financial year and have been revised significantly upwards from September 2012, resulting in a high inflation of 19.2 per cent on a year-on-year basis. Although these revisions have created upward pressure on inflation, they are absolutely critical for lowering fiscal deficit.

With gross domestic product growth falling to 4.5 per cent in the third quarter of 2012-13 and core inflation declining to 3.8 per cent in February, CRISIL expects RBI to adopt a pro-growth stance in its monetary policy review this month and cut repo rate by 25 basis points.

In 2013-14, average WPI inflation is likely to decline to 6.5 per cent, led by expectations of higher agricultural output (assuming normal monsoons), lower international crude oil prices and weak demand-side pressures.

We believe softening inflation will prompt RBI to cut the repo rate by another 25-50 basis points during 2013-14.