On a year-on-year basis, pulses inflation may still look high at 22 percent, but given the 29 percent rise in area sown under pulses, a fall in pulses inflation in coming months looks likely. This coupled with the base effect can take inflation even below 4 percent by November. Thereafter the base effect itself will pull up inflation to between 4.5-5 percent.
Given this trajectory until March 2017, space definitely opens up for one rate cut probably in October. The more tricky part to guess is whether the governor will resist the pressure to cut again in the December 6 policy. In fact there are some who would like the governor to give a 50 bps cut on October 4.
It looks unlikely that governor Patel can take that leap. Here’s why: The fall in inflation in August is largely because of the very volatile food basket. Even as vegetables and pulses brought down inflation from 6.1 percent to 5.05 percent in August (aided by base effect), it is useful to remember that from March to July inflation had shot up from 4.8 percent to 6.1 percent largely because of these elements.
There are lurking dangers to food inflation going forward as well. Monsoon rains have played truant in the north western regions. This can put pressure on cereals, which were in any case ticking moderately higher in August as well. Milk prices have been rising globally and at home sugar prices bear watching.
Secondly, aside from the volatile food items, core inflation or services inflation, excluding food, fuel and petrol products, has remained around 5 percent. In fact after falling seminally from over 6 percent in 2014 to 5-5.5 percent this year, they have been unable to fall below 5 percent. It may therefore be safe to conclude that the Indian economy’s stable inflation rate is 5 percent.
If governor Patel were to stick with the previous regime’s 150 basis point positive real rate, he already has little space to cut rates. For two cuts, we need to wait to see if the new governor’s approach to real rates, is different from that of his predecessor.
Thirdly, governor Patel may find it difficult to give that second cut considering two inflationary events next year. The implementation of the seventh pay commission’s rent allowance will result in a 60 basis point upward push to inflation. Also, the implementation of the GST from April 1, can give a further push to inflation.
Finally it will be wise for the fixed income markets not to price that second cut, simply because of the many imponderables that lie ahead. Firstly, the monetary policy committee could be constituted before this Oct 4 policy. Even if it is, it can have a meaningful impact only by December. Who will be the members of this committee will determine what impact this committee has on the future rate action of the RBI. Thirdly, who will be the next deputy governor appointed to the position vacated by Patel will be relevant.
Fourthly, the market needs to know what is the intent of governor Patel and the MPC towards moving to the RBI’s self-given goal of 4 percent CPI by January 2018.And finally there is the global scenario which appears can turn volatile on a dime.
As of now, one cut may be in the bag. Two is too much to ask.