An unexpected spike in India’s inflation rate for August has dashed hopes of a rate cut when the central bank meets on Monday, even as the government finally gave into calls to rein in its fiscal deficit by hiking fuel prices.
The Reserve Bank of India (RBI) has held its benchmark rates steady at 8 percent since April, waiting for signs of progress on both fiscal and structural reforms.
In a long-awaited move, the government on Thursday raised the price of heavily subsidized diesel by 14 percent in an attempt to trim its deficit. However, the jump in the wholesale price index to 7.55 percent in August from 6.9 percent in July, has complicated matters for the central bank, whose mandate is to ensure price stability, say economists.
“The latest steps to consolidate public finances, especially the diesel price hike yesterday (Thursday), could be a tempting opportunity for the central bank to offer a vote of confidence to the new Finance Minister, but the (inflation) data will make it more difficult for the RBI to cut rates,” Dariusz Kowalczyk, Senior Economist at Credit Agricole, said in a note.
Kowalczyk, who expects the central bank to hold off on further rate cuts until the fourth quarter of 2012, said such a move would be “illogical,” given signs of mounting broad-based price pressures.
In addition to rising headline inflation - which measures all items including food and fuel - manufacturing inflation in August jumped to 6.1 percent from 5.6 percent.
Robert Prior-Wandesforde, Director of Asia Economics at Credit Suisse, agrees that the likelihood of a rate cut is slim this time around.
“While many had begun to speculate that the RBI would cut the (benchmark) repo rate at next Monday's meeting, this (inflation) release unfortunately makes this much less likely,” Wandesforde wrote.
Against consensus expectations, Barclays’ Economist Rahul Bajoria says the central bank could come up with some form of monetary easing, given signs of progress on fiscal consolidation.
“The diesel price hikes were an important fiscal measure. The ball is in the RBI’s court now,” he said.
If the RBI doesn’t reduce rates by 25 basis points, it could resort to other monetary tools to increase liquidity, including cutting the Cash Reserve Ratio (CRR) or the amount of cash banks have to keep with RBI, said Bajoria.
By CNBC's Ansuya Harjani