Sunday 30 September 2007

Inflation at 5-yr low

Inflation at 5-yr low 3.23% due to decline in food prices


The inflation number has come surprisingly lower and that is a huge development for the bond markets. One was expecting a higher inflation of 3.47% or 3.50% but actually the week-on-week inflation has dipped rather considerably.


The inflation number has come surprisingly lower and that is a huge development for the bond markets. One was expecting a higher inflation of 3.47% or 3.50% but actually the week-on-week inflation has dipped rather considerably.

Inflation is quite lower than the market expectation and expectation of RBI as well. Till the end of November, it is largely a statistical play, which will show but the headline and inflation index has actually come off the four ticks lower. So it might be a beginning. Primary articles are showing some softness very clearly and may see inflation hovering well below 4% until November. The key to all this is how does the government decide about the fuel prices, is it completely the burden on the oil bonds or does it really pass some bit of it on the consumers as well? Even if it does, estimate shows that it is unlikely to cross even 4.75-5% through the year.

Inflation is a positive factor where interest rate scenario is concerned. Interest rates by RBI estimates are not likely to be looked as its more the liquidity management. Currently if one look at the RBI intervention in the forex markets, clearly the pressure is once again on liquidity. RBI did MSS off dated bonds few days ago but the MSS trigger is close to 1,35,000 and the first option that RBI would look at is see for a ceiling of MSS limit rather than go in for a CRR hike. There is a huge influx of liquidity despite lower inflation, RBI may not look at a rate cut.

Inflation has come in at close to a five year low of almost 3.23% for the week ended September 15 due to a decline in food prices. These numbers are below expectations. 3.5% was what the market was expecting. But inflation has actually come in lower, both week-on-week and year-on-year, inflation has fallen. So, there is no taking away from the importance of that number and inflation number has fallen largely because primary products have fallen, that means food articles have fallen, which is a very good sign.

This kharif has been better than what market expected. This kharif season, it was expected that the long range monsoon forecast will be about 2 percentage points lower than the long-term average. It has actually turned out to be 5% better than the long-term average. So, kharif is better than expected and that perhaps has started to impact food prices. That is genuinely a positive. We cannot run away with the thought that inflation will continue to go lower. The base effect is wearing off. Also, a look at crude prices and a look at the global metal prices, perhaps the trend will not continue, but no taking away from the positive part of this news. Inflation is lower, and largely because of food articles which is good.

Alternately, the other way to suck out the liquidity is to increase CRR, cash reserve ratio means the amount of cash that banks have to keep as a percentage of their deposits is being increased. At the moment 6.5% they can hike it to 7% that is another way of keeping out cash. Now the pros and cons of a CRR hike. If you do hike the CRR hike in the past it has sent a rate hike signal to the market. Now that could be justified by the RBI Governor because even if the Wholesale Price Index is coming down, the Consumer Price Index, which was announced today, is at a high of 7.25% for industrial workers for the month of August. Also credit loan growth by banks which was falling in the first half in this last reported fortnight of September has actually gone up. So, perhaps the RBI Governor could be justified in hiking the CRR. On the other hand, the market is also of the opinion that even if CRR is hiked, perhaps rates will not go up. So, the whole point is that because of this rush of liquidity, there is a speculation that CRR could be hiked. But going by market rates today, it looks like the CRR is not being expected at least till October 30, that is the credit policy.