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RBI may keep Interest Rates Elevated on More than Estimated Inflation

RBI may keep Interest Rates Elevated on More than Estimated Inflation

RBI may keep Interest Rates Elevated on More than Estimated Inflation

India’s wholesale price inflation hit a three-month high in March, faster than economists estimated and helping maintain pressure on RBI – India’s central bank to tick to the tight policy stance and keep interest rates elevated. Rising inflation, coupled with a slump in industrial production and merchandise exports and the risk of less-than-normal monsoon rains this summer, calls into question assumptions that the worst is over for Asia’s third-largest economy. Policy bias will be for further rate hikes in the second half of FY14/15 when the potential El Nino development and impact on southwest monsoon become more apparent.

The WPI – wholesale-price index rose 5.7% from a year earlier, compared with 4.68% in February, on higher food, fuel and manufacturing costs. It was the quickest pace since December 2013 and snaps a three-month easing trend. The January WPI inflation reading was also revised up to 5.17% from 5.05% earlier. Elevated inflation has prompted RBI Governor Raghuram Rajan to raise the benchmark rate 75 basis points since taking over the Reserve Bank of India in September. After raising lending rates three times (to 8% from 7.25%) since last September, the Reserve Bank of India left its policy repo rate unchanged at 8% this month. The next policy review is due June 3.  Risks to inflation arise from guaranteed prices for farm products, higher energy costs and government spending on subsidies, Rajan said. He added there’s also a threat from less-than-normal monsoon rains due to possible El Nino effects, which affect weather worldwide and can roil agricultural markets.

India’s struggle with a prolonged spell of high inflation and low growth:

While economic growth has almost halved to below 5% for the past two years, the worst slowdown for the South Asian nation since the 1980s, retail inflation has been averaging around 10%. Adding to the woes, recent non-seasonal heavy hail and rains in several parts of the country have damaged crops extensively and driven up food prices. Meanwhile on the other hand, a continuing slump in investment and consumer demand resulted in a surprise 1.9% annual contraction in industrial output in February and exports fell for a second straight month in March, widening the trade deficit to a five-month high.

A possible El Nino weather threat

“El-Nino and its consequences on the Indian economy is a tail risk at this juncture,” analysts at DBS Group Research wrote in a note last week. “But if these materialize, then the economy would remain in a soft patch in fiscal year 14/15.”

From Reuters

Compounding growth worries is an uncertain outlook for summer monsoon rains due to a possible El Nino weather event that affects wind patterns and can trigger both floods and drought.

Australia’s Bureau of Meteorology last week predicted that the chance of an El Nino weather event developing in 2014 now exceeded 70 percent.

A strong El Nino in India would trigger lower production of summer crops such as rice, sugarcane and oilseeds. In 2009, it had turned monsoon rains patchy, leading to the worst drought in nearly four decades which shot annual food inflation up to more than 21 percent.

Such a scenario would further compound the challenges awaiting a new government that takes over in New Delhi after national elections in May.

Persistently high inflation has become a feature of the Indian economy in the last five years and is widely expected to haunt the ruling Congress party in the elections which began last week. The opposition Bharatiya Janata Party’s leader Narendra Modi, a hot favourite to head the next government, says he will create a price stabilization fund to combat inflation and set up special courts to try those who hoard goods.

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