Expect no rate cut in FY15

In August, Wholesale Price Index (WPI)-based inflation registered a five-year low of 3.7 per cent and Consumer Price Index (CPI)-based inflation too nudged below 8 per cent. However, WPI is no longer RBI's preferred inflation gauge, so there is no point hairsplitting over it. RBI's interest rate decision will be guided primarily by the trajectory of overall CPI-based inflation. What this means is that a sustainable decline in food inflation, which has over 50 per cent weight in CPI, will be the key to cuts in repo rates.

CPI-based inflation has been on a downward trajectory from 10.2 per cent in 2012-13. In this financial year, we expect it to drop to 8 per cent due to some positive developments, notably the softening of global crude prices and some proactive steps by the government to control food inflation. These factors will help rein in CPI-based inflation within the central bank's target of 8 per cent by January 2015, but it is next year's stiff target of 6 per cent (by January 2016) that will keep the RBI hawkish on the rate front. Over the next few months, low crude prices will keep a tab on inflation via direct and indirect effects.

The government's resolve thus far not to raise minimum support prices, its decision to release excess food stocks and extend credit lines to states to import edible oil pulses, and crack down on hoarding will all help keep a check on price rise in these categories. But the risk to food inflation this year from fruit and vegetables and coarse cereals remains.

The decline in core CPI-based inflation (excluding food and fuel) to 6.9 per cent in August, the lowest since its inception in 2012, does not give much relief. If we exclude household requisites and transportation from core CPI, core inflation in August remained unchanged from 7.7 per cent in July. With the pick in growth, core inflation could come under pressure again.

Soft crude prices will cut fuel subsidy bill and help contain fiscal slippage this year. This does give the RBI leeway to continue to cut Statutory Liquidity Ratio (SLR) in its end-September bi-monthly policy, but not enough room to cut the repo rate.

The author is chief economist at CRISIL