Rupee, retail inflation to push back rate cuts

Falling rupee and a stubborn retail inflation will most likely keep the Reserve Bank of India (RBI) from cutting rates in the upcoming monetary policy review, despite weakening industrial output trends, say economists.

Poor demand, coupled with power and fuel shortages, has further slowed industrial production in April to a mere 2% compared with 3.4% in March.

Manufacturing, which constitutes about 76% of industrial production, grew 2.8% in April from a year earlier, government data showed. Mining production fell 3%.

But a weakening rupee is making it difficult for the central bank to cut rates to aid growth.

“We don’t expect a rate cut because heavy depreciation of rupee has happened, which raises possibility of an inflation passthrough. The RBI will want to wait before taking any action of rates,” said Abheek Barua, chief economist at HDFC Bank.

The rupee has depreciated 5.57% in the last one month on stronger dollar and FII outflows. The currency is expected to stay under pressure.

“With growth moderate by Indian standards and inflation easing in response to softer domestic demand and a weaker commodity cycle, the RBI is likely to deliver a few more rate cuts in coming months, although the timing may get impacted by the recent weakness of the currency,” said Leif Eskesen, chief economist for India and Asean at HSBC.

A still stubborn consumer price index has also lowered hopes further.

The CPI, also known as retail inflation, in May came in at 9.3%, mainly on higher food and fuel inflation, and could prompt a pause in rate cuts.

“Given sticky CPI inflation and the difficulties in financing the current account deficit, we remain comfortable with our view of no rate cut at the June policy meeting,” said Nomura economists Sonal Varma and Aman Mohunta.

This is particularly troubling given wholesale inflation has trended down significantly, pointing to the possibility that lower input costs are not getting passed onto consumers.

The central bank has reduced the repo rate by 75 basis points since January to 7.25% and cash reserve ratio to 4% already as it shifted focus to growth from inflation. Banks, however, have not been able to pass through the benefit fully to borrowers yet.