Time for a cut

The case for a rate cut in the near future has gained ground after the release of the consumer price index for March. CPI inflation fell from 8.1 per cent in the first quarter to about 5.2 per cent for the last quarter of 2014-15, with March posting a lower inflation rate than February. While the Reserve Bank of India seems committed to an accommodative monetary policy, having cut the repo rate by 50 basis points since the start of the calendar year, it could have done more. Even after allowing for ‘spreads’ for risk, external commercial borrowings are cheaper at prevailing domestic interest rates. Corporate sector debt has doubled over five years to $120 billion, which could upset financials once the US raises interest rates and pushes up the dollar — in all probability later this year. The rupee could come under stress, with a possible reversal of arbitrage-driven debt flows in the event of ‘normalisation’ of US policies. Debt inflows — ECBs and FIIs — could be affecting the competitiveness of our exports, which grew by just 4 per cent in dollar terms between April and December 2014, against 6.6 per cent in the same period in 2013. The ‘taper tantrum’ of mid-2013 tells us that we should be better prepared, even as monetary easing by the EU and Japan may absorb some of the liquidity shock this time. Better then to start cutting rates soon, while the window of opportunity still exists so that exchange rate and asset market volatility is kept to a minimum.

While it is true that the CPI broadly represents the aam aadmi ’s inflation experience, the wholesale price index should not be forgotten. It is worth considering whether a fall in WPI core inflation from 4 per cent in the first quarter of 2014-15 to 2 per cent in the third quarter is cause for optimism or concern. Given the supply bottlenecks in infrastructure and mining, a really low level of inflation is a pointer to weak manufacturing demand, which only suggests that the revival is yet to gain momentum. Core inflation has a weight of 55 per cent in the WPI as against 47 per cent in the CPI, while food has a weight of about 24 per cent in the WPI, against 46 per cent in the CPI. Therefore, the CPI focuses more on headline than core inflation; relying exclusively on it could lead to an imbalanced view of the growth-inflation dynamics. Besides, it cannot be overemphasised that food prices do not respond to interest rates.

The WPI should be improved upon to become a reliable producer price index so that the gap between it and the CPI becomes a reliable measure of the cost of intermediation. With the data on growth posing its share of problems, let us move towards some clarity on prices. The Urjit Patel Committee on ‘inflation targeting’, using the CPI, considers a lower bound of 4 per cent for inflation. However, factoring in the WPI may help get the growth-inflation policy mix right.

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