RBI's dilemma intensifies

CPI and IIP head in opposite directions

Going by the release of the quarterly balance of payments numbers on June 30, and the numbers for the index of industrial production (IIP) for May and the consumer price index (CPI) for June last Friday, it appears that a new principle is in place. If the news is good, announce it during market hours. If it is bad, wait until the market is closed. The IIP and CPI numbers certainly warranted this caution. Together, they suggest that even as growth is decelerating, inflation is actually accelerating. Looking at the IIP, the index declined by 1.6 per cent relative to May 2012, sharply below consensus estimates, which were anticipating a small positive number. It has to be kept in mind that the positive growth seen during the past two months was almost exclusively attributable to garments, the growth in which slowed to a mere 14.3 per cent during May, still putting the April-May growth rate at a rather striking 50.6 per cent! Most of the other industry groups continued with their sluggish performance of the past several months. Whichever way the numbers are looked at, they show no signs of a recovery under way, belying the confident assertions to this effect by government spokespersons. These numbers provide early indications that growth projections for the current year will have to be scaled down from their already modest levels.

On the other hand, consumer inflation has accelerated somewhat, clocking almost 9.9 per cent over June 2012, about half a percentage point higher than the previous month. As has been the case for so long now, the main reason for this is food. Strikingly, the drivers of food inflation seem to have shifted from non-cereal items to cereals, which saw prices increase by almost 18 per cent. As regards the prices of manufactured goods, there has been something of a disparity between increases recorded by the CPI and the wholesale price index (WPI), for which the numbers for June will be announced on Monday.

These patterns make the Reserve Bank of India's (RBI's) decision on July 30 even more difficult. The recent depreciation of the rupee has already been highlighted by it as a renewed source of inflationary pressure, constraining the room for further interest rate cuts. Today's WPI numbers will provide an indication of how much dynamics have impacted inflation through higher prices of imports. If there is a reversal in the recent downward trend in both headline and core inflation, it will almost certainly stay the RBI's hand on July 30. In fact, unless RBI Governor D Subbarao's successor decides to follow a completely different tack for monetary policy, it is looking increasingly likely that the interest rate reduction cycle that began in April 2012 and reduced the repo rate by a cumulative 125 basis points has ended. In which case, the fundamental question has to be raised: where is the trigger for a recovery going to come from? With the government's attention currently distributed between the food security ordinance and finding ways to finance the current account deficit, that question is clearly not getting the priority it deserves. And, it will not wait until 2014 for an answer.