Much to the surprise, the Wholesale Price Index (WPI) inflation for April 2014 mellowed down to 5.20% in April 2014 from 5.70% in month prior. Despite the unusual rain and hailstorm experienced in western and northern parts of India in February and March, vegetable prices softened starkly.
 

Unexpected fall in WPI Inflation...

Data as on April 2014
(Source: Office of the Economic Advisor, PersonalFN Research)  

Slower pace of inflation in April 2014 was mainly on account of:

Food inflation:
As compared to 9.9% recorded in March, food inflation fell to 8.64% in April. A slower pace of price rise reported by vegetables - which went up only 1.34% in April as against 8.57% in the month prior, led to fall in food inflation. A Kitchen staple for many such onions contracted to 9.76% in April as against 1.92% in the month prior. Likewise, prices protein items such as Eggs, meat and fish too mellowed aiding food inflation to fall. But prices of fruits became expensive as they recorded a hike of 16.46% in April.

Fuel & Power inflation:
Fuel prices too softened to 8.93% in April from 11.22% reported in March. High speed diesel and LPG attributed to this constituent of inflation to report a fall. Likewise much slower pace of inflation in electricity too helped. But a close observation within the constituent reveals that petrol prices went up with decision to increase rates in the backdrop of elevated global fuel prices.

Manufacturing inflation:
Manufacturing growth has been cooling off as a result of which even inflation in manufacturing is dipping. As against 3.23% recorded in March, inflation in manufacturing reduced to 3.15%. Although the fall is not very substantial, considering the weight of manufacturing inflation in the WPI, impact has been felt.

PersonalFN's View on inflation:

With the official forecast of a below normal monsoon from Indian Meteorological Department (IMD) due to 60-65% chances of an El-Nino phenomenon, the risk to inflation, especially on food prices, is heightened. It is noteworthy that contrary to WPI inflation data, retail inflation (i.e. CPI inflation) has already hiked to 8.59% in April from 8.31% recorded in March; which reflects that the peril of unseasonal rainfall along with hailstorms in some parts of the country (in February and March) is already percolating down to retail prices. Moreover, now that diesel prices have been hiked recently (due to elevated global fuel prices), the risk also emanates therefrom as it diesel is an essential transport and industrial fuel.

So, would RBI cut rates in the next monetary policy review?

RBI has adopted inflation-targeting approach. By January 2015, retail inflation target has been set at 8% and 6.0% by January 2016.PersonalFN believes, going forward, RBI would be watchful to several factors that would pose a threat of pushing the retail inflation up. Falling industrial growth may not be considered a reason for lowering rates if retail inflation stays high. IMD has predicted that rainfall would be 5% lower than its multi-year average this monsoon season, with a possibility of model error of +/- 5%. Although IMD rules out a possibility of getting excess rain this season; it has not yet predicted any significant shortfall in rain. The updated forecast is likely to be issued in June. This may provide more clarity. If RBI sees any upside risk to inflation and if inflation in the interim indeed rises; it may break its status quo and even consider raising rates. But for now RBI may keep policy rates unchanged.

In addition to these, factors such as policies of new Government, fiscal management and approach of the new Government in containing inflation would impact the decision making of RBI. Strong policy measures may provide RBI some room to give some incentives to growth.

Impact on equity markets...

At the moment, market is apathetic to any other news other than outcome of Lok Sabha elections. Under normal circumstances or in the absence of any other major event, markets may have reacted negatively to falling industrial production and rising inflation; but for now poll results remains the single biggest event for equity markets. PersonalFN is of the view that if the trend of rising inflation and falling growth continues even under new Government, markets may start worrying as they are hopeful that NDA led Government, if comes to power, would boost growth.

Impact on debt markets...
Inflation and fiscal management of Indian Government have been affecting debt markets thus far. Therefore, rising inflation is certainly a negative for Indian debt markets. This is why debt investors haven't gained much from the positive sentiment that has taken equity markets to a new level. India still struggles on the fiscal deficit front. Moreover, inflation remains sticky. Continuous issuance of long maturity debt may keep yields high, since yields on Indian sovereign debt is a function of supply of Indian debt, Sovereign rating of India and yields on Government debt of other nations, especially that of the U.S.

It has been seen that, UPA Government fell short of achieving revenue targets especially due to shortfall in tax receipts. On this backdrop the new Government would look at revising tax laws and implementing Direct Tax Code (DTC) and Goods and Services Tax (GST). Weaker industrial performance puts pressure on achieving aggressive revenue targets.

On the external front, containing Current Account Deficits (CAD) and enhancing forex kitty remain top priorities. Performance of the new Government on this front would have an impact on the Indian debt markets as well.

PersonalFN is of the view that, till anything changes on these fronts, it is unlikely that debt markets would be affected in a significant manner. They might just stay responsive to demand-supply dynamics. Having said this, any bad news on the inflation front as well as on fiscal deficit front, may negatively affect Indian debt markets.

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