"Inflation Report"
Inflation continues to drop; hitting six years low
Wholesale Price Index (WPI)-based inflation for the week-ended February 21, came in at 3.03% Y-o-Y, largely in line with expectations (Edelweiss: 2.99%; consensus: 3.07 %). It is the lowest since November 2002. The overall trend for prices continues to remain downward due to weakening demand.
Food articles and metals primary drivers for week's drop
On a W-o-W basis, primary articles' inflation declined 0.2% due to lower prices of food articles, particularly fruits and vegetables. Non-food articles declined marginally owing to lower prices of fibres and oilseeds. Metals and textiles were the primary drivers for the drop in manufactured group inflation. Fuel group inflation continues to remain unchanged.
Low prices and base effects to push down inflation to negative territory
With rapid correction in commodity prices, inflation expectations have come down significantly. Base effects for WPI inflation are also likely to remain markedly favourable in the coming weeks. Even if overall prices stay constant at the current levels, Y-o-Y WPI inflation could drop close to zero by March 2009. The current phase of rapid softening in prices reinforces our belief of negative inflation Q1FY10 onwards.
RBI cuts policy rates; more action imminent
RBI cut its benchmark rates yesterday by 50bps each, as per our expectations, following which repo and reserve repo rates stand at 5% and 3.5%, respectively. The CRR has, however, been kept unchanged, as expected, keeping in view adequate liquidity in the system at the moment. Given the rapid deceleration in economic activity, supporting growth continues to be RBI's primary concern. The rapidly softening inflation offers RBI additional headroom for further monetary easing.
We believe, RBI is likely to have two more rounds of cut in repo and reverse repo rates by June 2009. However, cuts in policy rates will now be in smaller quantum (50bps) only. Also, though liquidity is ample in the system currently, it may come under pressure Q1FY10 onwards given continued large government borrowing. In such a scenario, RBI is likely to reduce CRR by up to 200bps to ease pressure on interest rates. RBI may also use open market operations (OMO) aggressively in FY10 to provide liquidity to the market.
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