As the new government battles stubbornly high food inflation, the pre-budget economic survey on Wednesday predicted that the headline inflation would ease by year end, providing room to the RBI to cut interest rates. "Headline WPI (wholesale price index) inflation is expected to moderate by the end of 2014. However, risks to the outlook stems from possible sub-normal monsoon and higher crude oil prices (on account of the crisis in Iraq)," the Economic Survey 2013-14 tabled in Parliament by Finance Minister Arun Jaitley said.
As inflation eases, it is expected that the RBI would adopt a more accommodative stance and bring down interest rate. "The monetary management challenge will also be helped by fiscal consolidation and addressing of supply side constraints that exacerbate food inflation. All these factors, in tandem, are expected to create room for monetary easing later this fiscal year," it said.
However, WPI inflation rose to a five-month high of 6.01 per cent in May from 5.20 per cent in the previous month mainly driven by higher prices of food items.
Talking about the challenges, the Survey said, the Meteorological Department has predicted below-normal rainfall at 93 per cent of the long period average with 70 per cent probability of an El Nino occurring. The odds of a drought are 60 per cent now, compared with 25 per cent in April, Skymet, a private forecaster said.
Besides, the other most prominent risk (to price rise) is the impact on oil prices on account of the crisis in Iraq. Crude oil prices are hovering around USD 110 per barrel. Two-thirds of India's oil needs are met through imports. Iraq is the second-largest oil supplier after Saudi Arabia.
The survey said inflation showed signs of receding with average wholesale price index (WPI) inflation falling to a three-year low of 5.98 per cent during 2013-14 compared to 7 and 9 per cent over the previous two years. Consumer price inflation, though higher than the WPI, has also exhibited signs of moderation with CPI (new-series) inflation declining from 10.21 per cent during 2013-14 to about 9.49 per cent in 2013-14, the survey said.
Food inflation, however, remained stubbornly high during 2013-14, reaching a peak of 11.95 per cent in third quarter. Highlighting reasons, the survey said, high inflation, particularly food inflation, was the result of structural as well as seasonal factors. Contribution of the commodity sub-groups, fruits and vegetables, as well as egg, meat and fish to the food inflation has been very high, it said.
However, inflation in Non Food Manufactured Product (WPI core) has remained benign throughout the year, with average inflation moderated to four year low of 2.9 per cent in 2013-14, which indicates that underlying pressures of broad-based inflation have somewhat eased, it said. IMF has projected that most global commodity prices are expected to remain flat during 2014-15, which augurs well for inflation in emerging market, including India.
The survey noted that the course of gradual monetary easing that had started alongside some moderation of inflationary pressures at the beginning of the financial year 2013-14 was disrupted in May 2013, following indications of possible tapering of the US Fed's quantitative easing. Following the ebbing of volatility in the foreign exchange market, it said, RBI initiated normalisation of the exceptional measures in a calibrated manner since its mid-quarter review (MQR) of September 20, 2013.
The interest rate corridor was realigned to normal monetary policy operations with the MSF rate being reduced in three steps to 8.75 per cent between September 20, 2013 and October 29, 2013, it said. RBI in its Third Quarter Review of Monetary Policy on January 28, 2014, hiked the repo rate by 25 basis points to 8 per cent on account of upside risks to inflation, to anchor inflation expectations and to contain second round effects, it said. The move was intended to set the economy securely on the disinflationary path, it added.