CPI inflation at 7.59% may compel RBI to change its stance

CPI Inflation for the month of Jan-20 came in at a 68-month high of 7.59%. This was largely driven by food inflation but core inflation has also chipped in with its own contribution. That could be something for the RBI to be cautious.

Double whammy on inflation

If you look at the inflation number for Jan-20, then it is up to the highest level in nearly 6 years. This is despite the fact that the food inflation has come down marginally compared to December. Then why is CPI inflation higher? Firstly, fuel inflation has inched up during the month of January. Secondly, the core inflation (non-oil and non-food) has also inched up during the month of Jan-20. In the last few months, it was only food inflation but now core inflation is also proving to be a worry for the RBI. That could be the double whammy!

What about IIP slowdown?

One argument for the rate cuts has been that the IIP has again turned into negative territory after a brief interlude. However, the problem appears more of a structural issue of weak capacity utilization and hence rate cuts are not going to be of much use. The hints from the RBI are clear that, going ahead, the focus will be more on fiscal than on monetary policy. With inflation likely to remain higher, rate cuts may not really happen purely because of weak growth. That argument may not hold.

Are rate cuts ruled out?

One question that analysts and bond traders are posing is; whether further rate cuts are now ruled out? Based on the headline inflation and the estimates of consumer inflation, it looks like further rate cuts by the RBI may be ruled out for at least in the next two policies in April and June. Any change in the strategy of the RBI may only happen after the first estimates of Kharif and rains come in. While rate cuts may not happen, it also looks unlikely that the RBI would hike rates with the current IIP and GDP scenario. One of the reason, financials corrected sharply post the inflation number was the near impracticality of additional rate cuts.

Will the stance change?

In the February monetary policy, the RBI “held its stance at “Accommodative” indicating room for further cuts. That had actually gratified the markets. But the sharp spike in inflation poses a new problem for the RBI on the capital flows front. For a long time, Indian debt was attractive purely because real returns were among the highest among the large economies at 4%. With inflation at 7.59%, that real return is negative and that is evident in bond investors getting cautious on Indian debt. To mollify the global investors, it is likely that the RBI may shift stance from “accommodative” to neutral in the April policy. That could really be the joker in the pack!