Economy: Headline inflation steady, RBI to still go for an easing tomorrow :: Kotak Securities PDF link

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Economy
Inflation
Headline inflation steady, RBI to still go for an easing tomorrow. Headline WPI in
March moderated marginally to 6.89% from 6.95% last month. However, non-food
manufactured inflation decelerated to 4.66% from 5.75%. FY2012 headline inflation
averaged 8.81% from 9.57% in FY2011. Despite the desired comfort on headline WPI
inflation not being achieved, we expect the RBI to lower policy interest rates with a repo
rate cut by 25 bps at its annual policy meeting on Tuesday. This is probably to provide a
boost to the nascent recovery as any further erosion of growth could be detrimental to
the tax revenue generation capacity of the government. The hikes in taxes and likely
increases in administered fuel prices in the course of the year should also keep a check
on the demand-side parameters in the economy.
Manufactured products inflation remains benign on favorable base
Manufactured products inflation fell to the lowest since December 2009 to 4.87% from 5.75% in
February, while non-food manufactured products inflation came in at a 2-year low of 4.66% from
5.75%. Over the past few months, the sharp moderation in headline manufactured products
inflation has come on the back of a favorable base effect (manufactured product index has risen
on an average by 0.31% mom in 4QFY12 versus 1.18% mom in 4QFY11). This is evident as on a
monthly sequential basis, manufactured products and core inflation are yet to show any significant
comforting sign (core inflation rose 0.38% mom in March from 0.16% in February 2012). Within
the manufactured segment, the inflation momentum was the strongest in iron and semis (2.05%
mom), edible oils (1.58% mom) and cotton textiles (1.29% mom), reflecting the trends in global
commodity prices as also the impact of a weaker currency. While manufactured products inflation
could revert to 6.5-7.0% in FY2013E on the back of a waning base effect and higher excise taxes,
the RBI could take heart from a downward trajectory in the CRB commodity index and a recent fall
in the international crude oil prices. The RBI had also recently been pointing out to the constriction
in pricing power of corporations as a sign of demand compression in the economy.
Primary articles inflation rebounds on higher food prices
Primary articles inflation surged to 9.62% from 6.28% in February, led by a 2.4% mom jump in
the index as well as an adverse base. The strength in primary articles was led by a sharp increase in
all the three sub-indices. Food articles index jumped by 2.34% mom taking the annual inflation
rate to 9.94% from 6.07%. Within food, vegetables remained the key pressure point with prices
rising by 30.57% from 1.52% in February (index rising 6.43% mom). Further, milk, eggs, meat &
fish index rose 16.4% mom from 15.4% mom in the previous month. Inflationary pressures were
also strong in minerals (28.56% yoy, 4.07% mom).
Interest rate cycle set to reverse
The steadying out in the inflation trajectories (both headline and core) along with growth
moderations could nudge the RBI to reduce policy interest rates. We expect the RBI to cut the repo
rate by 25 bps to 8.25% at its annual policy meeting. While the RBI might still not feel
comfortable with the pace of softening of inflation (primary articles prices skew the picture), the
reduction in fiscal accommodation in terms of a hike in the excise and service taxes and the
budget’s promise to cap subsidy bill at 2% of GDP could tilt the RBI in favor of a cut. To contain
the subsidy bill, especially fuel, the Government would have to hike domestic prices of fuel
products. In turn, all of the above would be inflationary, but could also help arrest demand in the
economy and thus balance out the risks of any runaway inflation from the demand side. However,
the aggressiveness of rate cuts by the RBI would be missing as inflation risks would remain high
priority, thus restricting the cumulative repo cuts to around 75 bps in FY2013E.