Inflation will be game-changer

Near-term outlook remains a challenge as inflation may not come off meaningfully to merit sharp rate cuts

After reforms, it’s time to focus on India’s macro-economic indicators again, which continue to send out conflicting signals. Wednesday saw two different sets of data, one of which showed signs of renewal, while the other pointed to structural issues that the economy continues to face. Industrial production for October grew 8.2 per cent, much ahead of estimates but the consumer price index rose by 9.90 per cent in November. Economists are confused by this “macro muddle”, and as a consequence, divergent predictions on growth are being put out. Days after Goldman Sachs talked of India’s improving outlook in 2013, HSBC Global Research downgraded its gross domestic product estimates for FY13 to 5.2 per cent from the earlier 5.7 per cent.

So, what can one make of the divergent pieces of data? For starters, growth is expected to move sideways over the next few months. The near term continues to look challenging. Goldman Sachs expects growth to pick up in the second half of 2013. HSBC’s Leif Eskesen believes recovery will be more protracted. Inflation has not come off despite commodity prices cooling globally and domestic demand softening. Clearly, the central bank is unlikely to act on policy rates just yet.

Inflation is going to be the game changer in times to come, as it would determine the Reserve Bank of India’s (RBI) rate action. ICICI Securities estimates the annual inflation at 7.08 per cent in November, the lowest since December 2009. Despite this, RBI might not start cutting the benchmark rates from December. Other economists like Deepali Bhargava of Espirito Santo, however, believe inflation for November could come in at 7.68 per cent year-on-year. Even if inflation comes in above RBI's comfort level, economists expect the central bank to cut rates only next year.

This is because none of the components of inflation is showing any sign of sharp deceleration, as the high prices are a result of supply-side issues. Though prices of most food articles have seen some downtrend, the sharp spike in prices of cereals has kept food inflation higher. Food prices are likely to cool further due to seasonal factors and also on a better rabi crop. Prices of most industrial inputs have come down globally but industrial input inflation has stayed elevated. Energy inflation, too, has stayed at around 11.8 per cent over September and October. Core inflation, which had remained in the five per cent region for most of the year, inched up to 5.8 per cent in October due to increase in prices of textiles, fertilisers and cement. Eskesen of HSBC believes policy rate cuts are not on the cards until 2013 and at the earliest during the first quarter. “Moreover, the room to cut is limited given the supply-led nature of the slowdown; we only expect 50 basis points in rate cuts next year,” he adds.