The September Consumer Price Index (CPI) numbers were the first indication of the waning of the base effect. In the previous policy, the RBI governor had spoken about the base effect problem with respect to inflation. The corresponding period to July and August last year were high inflation months and hence this year was likely to appear lower due to the base effect. Since inflation is a point-to-point number it tends to get influenced by base effect quite drastically. In fact, this base effect was the key reason why the RBI governor had expressed concerns about a rate cut.
Base effect waning is visible…
The CPI for the month of September came in 4.4%, approximately 60 basis points higher than the CPI announced for the month of August. There was a sharp rise in the price of food products which contributed to the rise in CPI. Even according to government estimates this CPI number is likely to get closer to 5.5% by next year and sustain around those levels. Thus the waning of the base effect post September is likely to add roughly 170-200 basis points to the inflation number. A large part of the food price uptick was led by vegetables and a sharp rise in the price of pulses. In fact, the pulse inflation has forced the government to look at using the Price Stabilization Fund (PSF) to quell the prices of pulses.
WPI also becomes less negative…
Even the WPI, which has been negative for over 7 months now, continued in the negative territory. However, the extent of negativity improved during the month of September. From a level of -4.94% in August 2015, the WPI improved to -4.4% in September 2015. The number has two key implications. Firstly, a consistent negative WPI number indicates the possibility of deflation as it means that producers are not getting remunerative prices for their output. This typically has the risk of leading to cuts in production and jobs, a situation that is not too palatable. Secondly, a highly negative WPI with a positive CPI also indicates that more of the higher GDP is being captured by the government and is not accruing to the producers or to the consumers.
IIP output was higher…
The output for August 2015 as per the Index of Industrial Production (IIP) was up by 6.2% as against 4.2% in the previous month. That is a good 200 basis points improvement. This is good news because the recovery has been broad-based across the producer and consumer segments. More importantly, a higher IIP growth also means that money supply in the economy can be absorbed easily without igniting inflation. That is good news on the inflation front.
What does all this mean for the RBI guidance?
The RBI has already guided towards a benign interest rate regime as well as lower inflation. The RBI has already factored the base effect into its inflation calculations and hence this CPI number is unlikely to substantially impact the RBI thinking. The RBI, in its credit policy, had already projected inflation stabilizing at around the 5.5% mark, which seems to be perfectly achievable. From the RBI’s perspective, nothing much seems to have changed. They had projected the waning of base effect and that has had a 60 basis points effect on the CPI inflation. However, the RBI will also take heart from the fact that the IIP has grown by 200 basis points leaving enough room to absorb additional inflation.
The waning of the base effect was expected and largely provided for by the RBI. Hence it is unlikely to adversely impact the RBI thinking on rates. The RBI may probably pause for the time being on rate cuts till the base impact is clear by next month. Also the RBI will prefer to await the outcome of the Fed decision on a rate hike, which will be a crucial indicator for the RBI. Otherwise, the RBI may be inclined to pause in the November policy and then effect further rate cuts next calendar year after the Fed thinking on rates becomes clearer in December this year.
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