Anand Rathi: Inflation rises, but policy rates likely to hold

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India Economy - Inflation rises, but policy rates likely to hold

Primary prices remain stubborn, while manufactured products and fuel inflation rates are softening. Despite confusing signals from diverse data points, we expect inflation to ease from Nov ’10 and the RBI to hold rates in the next policy meet.

n       WPI inflation hardens. After being on a softening trajectory for four months, the WPI inflation marginally rose to 8.6% in Sep ’10, up from 8.5% in Aug ’10. The primary articles inflation, which rose to 17.5% in Sep ’10 from 15.8% in Aug ’10, is the key reason behind the slight rise in WPI inflation.

n       Broad-based rise in primary inflation. All major indices within primary category saw hardening of inflation in Sep ’10. The key price pressure came mainly from fibres, flowers, vegetables and eggs. Pulses prices saw major easing of inflation in Sep ’10.

n       Manufactured products inflation eases. The price index for manufactured products is hovering around the narrow band of 40bps since Apr ’10. Despite slight increase in the index, manufactured price inflation eased in Sep ’10. After rise for nine successive months, petroleum product prices eased in Sep ’10.

n       Contra signals. After peaking at 11% in Apr ’10, WPI inflation is largely on a softening trajectory. Yet, current inflation is well above the ‘RBI comfort zone’. We expect considerable softening of inflation from Nov ’10, mainly due to base effect. However, sharp run-up of global commodity prices coupled with elevated food prices in India remain concerns.

n       Inflation assessment and outlook. Nearly 50% of the WPI by weight is witnessing inflation of 5% or below. Inflation in India is being mainly driven by primary products. As the summer crop hits the market, we expect some easing in inflation. Our model suggests that in the base case scenario, the WPI inflation would soften to ~6% by Dec ’10 and to ~5% by Mar ’11.

n       Policy rate outlook. In Sep ’10, the RBI indicated that normalising of policy rates from the crisis lows has broadly been achieved and future rate action would depend on data signals. Confusing data signals – stubborn food inflation, rising global commodity prices, subdued growth outlook in industrialised countries and slowdown in the Indian industry – would make it difficult for the RBI to take a decision. Yet, we expect the RBI to maintain status quo on key policy rates during the Nov 2 policy, and hike policy rates by 25bps in remaining FY11.