Reserve Bank of India (RBI) governor D Subbarao's cautious words on inflation seem to have convinced the markets that the central bank is unlikely to cut the repo rate by 50 basis points when it meets on January 29 to review monetary policy. Both the stock and bond markets sold off on Wednesday as they reconciled themselves to a smaller cut of 25 bps. Late Tuesday, Subbarao had observed in a speech to students in Lucknow that although inflation has come down, it is still high. The governor had added that there was not enough room for monetary and fiscal stimulus.
Accepting that inflation had increased in the past few years, the RBI governor said in Barabanki, UP, on Wednesday that though the central bank had somewhat succeeded in containing it in the past two years, it is still there. “It is our priority to check price rise and will remain so,” he said.
The Sensex shed 0.85% while the 50-share Nifty slipped 0.90% on Wednesday while bond yields rose by 5 bps. The bond market had been factoring in a 50 bps hike with industrial growth staying sluggish – industrial output shrank 0.1% in November after growing 8.3% in October – but now believes the repo would at best be trimmed by 25 bps. Bonds had rallied last week before Monday's inflation data dashed hopes of a 50 bps cut.
Headline inflation based on wholesale price index dropped to 7.18% for December, the lowest in three years from 7.24% in November while core inflation fell to 4.2%, signalling a softening in prices. However, retail inflation came in at an uncomfortably high10.56%.
“When growth is slowing, you can stimulate the economy either by monetary easing or by fiscal stimulus, but both monetary and fiscal side have no room for stimulus. So, that is the big concern,” Subbarao was quoted as saying.
“We still believe the RBI will cut repo rates by 25 basis points since there is some turnaround in the inflation cycle,” said Abheek Barua, chief economist, HDFC Bank.
Barua said the relentless rise in consumer prices could play spoilsport. Core inflation which the RBI tracks closely for demand pressures has been consistently falling. Notwithstanding the volatility in the industrial output index, along with the lack of credit offtake, it reflects the slowdown in the economy.
For now, market participants hope that even though retail inflation could flare further given price hikes in fuel and transportation, Subbarao would cut rates as growth flounders.