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Interest rates must remain on hold for now as there is hardly any downward adjustment in core CPI inflation and the possibility of another shock to food prices remains high, according to Crisil.
Core CPI inflation excludes the more volatile categories of food and energy prices.
In a note, the credit rating agency said with Consumer Price Index (CPI) inflation now close to the RBI’s official target of 8 per cent for January 2014, the economy may have come to the end of the interest rate tightening cycle.
Retail inflation, as measured by the CPI, has fallen faster than expected in the last three months, from 11.2 per cent in November 2013 to 8.1 per cent in February. The note, released on the eve of the announcement of the first bi-monthly monetary policy by the RBI for the year 2014-15, reasoned that the current fall in CPI inflation is almost entirely driven by declining inflation in vegetables, with hardly any downward adjustment in core CPI inflation.
While overall CPI inflation has fallen 3.1 percentage points in the last three months, core CPI inflation has fallen only 0.1 percentage point and is still lingering around 8 per cent levels.
Crisil said a flashback shows there were supply-side shocks in each of the last seven years — which kept food inflation above 8 per cent in all but one year — even though monsoons were largely normal with only one drought year.
Thus, while the shock to vegetable prices may have abated, the possibility of another shock to food prices remains high, even if monsoons this year are normal and demand-side pressures remain relatively low, it added.
In addition, risks of an El Nino — a weather phenomenon that could disrupt monsoons — have begun to surface. Worsening of geopolitical tensions in Ukraine could also raise global oil prices and create upward pressure on inflation of oils and fats, the rating agency said.
With core inflation still close to 8 per cent, any shock to food prices could raise overall CPI above the RBI’s target of 8 per cent, cautioned Crisil.
The note said, “Given the persistent risks of a surge in food inflation in India, core CPI inflation will have to come down sharply if overall CPI inflation is to sustain below 8 per cent and move towards the 6 per cent mark by January 2016, as recommended by the Urjit Patel Committee.
“Only when such signs emerge, can there be a room for monetary policy loosening.”
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