WPI Inflation rises in May 14. Diminishes chances of a rate cut   Jun 17, 2014

After falling unexpectedly in April 2014 to 5.20%, the Wholesale Price Index (WPI) inflation inched-up yet again in May 2014 to 6.01%. Moreover, the data for March was revised upward to 6.00% from 5.70% posted in the quick estimates.

WPI Inflation inches up yet again
WPI Inflation for May 2014
Data as on June 2014
(Source: Office of the Economic Advisor, PersonalFN Research)

Rise in inflation in May 2014 was mainly on account of:

Food inflation:
The data here revealed that food articles (which have a weightage of 14.34% in WPI) rose to 9.50% in May 2014 as compared to 8.64% in the previous month. Prices of fruits witnessed an increase, with inflation thereto coming in at 19.40% for May 2014 vs. 16.46% in the previous month. This constituent saw a rather sharp increase, placing it in the double-digit terrain.

Likewise inflation in protein based items such as egg, meat and fish also witnessed an increase to 12.47% in May 2014 from 9.97% in the previous month. So once again, this constituent too inflation landed in the double-digit terrain.

But, vegetables prices have shown some relief for the common man as the inflation therein fell from 1.34% in April 2014 to -0.97% in May 2014. Nevertheless, inflation in onions has risen to -2.83% in May 2014 from -9.76% in the previous month. Prices of tomato however remained unchanged.

Fuel & Power inflation:
Fuel and power inflation (which has weightage of 14.91% in WPI) too, rose to 10.53% in May 2014 from 8.93% reported in the previous month. Electricity and High Speed Diesel attributed to this constituent of inflation to report a hike. Inflation in Petrol too rose to 12.28% in May 2014 from 7.77% in the previous month.

Manufacturing inflation:
Inflation in manufacturing growth has increased very mildly due to the lull in industrial activity. The data came in at 3.55% in May 2014 up from 3.15% reported in the previous month. Although the rise is not very substantial, considering the weight of manufacturing inflation in the WPI (64.97%), impact has been felt.

PersonalFN's View on inflation:

It is noteworthy that contrary to WPI inflation data, retail inflation (i.e. CPI inflation) has eased to 8.28% in May from 8.59% in the prior month. However, with the official forecast of a below normal monsoon from Indian Meteorological Department (IMD) due to 60-70% chances of an El-Nino phenomenon, the risk to inflation, especially on food prices, is heightened. 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 8.0% and 6.0% by January 2016. While the guidance to the 2nd bi-monthly monetary policy, has as dovish tone as the central bank said that if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance and it may set the downward path for interest rates if inflation glides as projected by RBI. In our opinion the WPI inflation data would deter the RBI from reducing policy rates soon.

The RBI would be watchful to several factors as they pan and their implication on inflation and the economy. You see, with Brent crude oil prices on a rise on account of sectarian tension in Iraq, the rise is not only from food inflation (due to a sub-normal monsoon on account of an El-Nino phenomenon), but also from fuel prices. It is noteworthy since crude oil comprises a dominant portion in India's import list, it would have implications on trade deficit, Current Account Deficit, Indian rupee and even fiscal deficit, if the NDA Government decides to keep domestic prices of diesel unchanged bearing the increase in subsidy burden.

So far on inflation and growth, the RBI and the Government seem to on the same page and are reciting in chorus; which is good. It is noteworthy that the BJP led NDA in its top agenda has also mentioned about curbing unacceptably high inflation.

Impact on equity markets...
There is a wave of optimism in India at present. Stock markets are rising on the hope that Mr Modi-led NDA Government will revive the sagging Indian economic growth. However, as S&P BSE Sensex has hit the silver jubilee mark of 25,000 points, valuations have started ringing the warning bell. There is doubt afloat on whether this rally will sustain for too long. While there is undoubtedly a hope for better tomorrow, policy announcements from the Government are awaited. However, the escalating sectarian tensions in the Iraq and its impact on crude oil prices may cause Indian equities markets to be a little slippery, for the reasons cited above. In fact the hope rally ahead of the full year budget for 2014 seems to have lost steam. The markets are now waiting for policy announcements, which would give a better sense of direction to investors and how the NDA Government would handle the macroeconomic challenges.

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 Mr Modi-led NDA 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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