Everybody expects the Reserve Bank of India (RBI) to cut its policy rate on Tuesday, with some predicting a 50 basis point cut. There are cogent reasons for a rate cut, such as the central government sticking to its fiscal deficit target for FY17, the lowering of interest rates on small savings schemes and the likelihood of commodity prices remaining low on account of the continuing growth slowdown in China.
However, the Nikkei Manufacturing Purchasing Managers’ Index (PMI) for March came in at an eight-month high of 52.4. In short, the manufacturing sector is looking up. And with output going up, so have output prices. In fact, the Output Price sub-index of the manufacturing PMI came in at a 16-month high in March (see chart 1). According to the PMI survey, higher cost burdens were passed on to clients. That suggests pricing power. Simply put, the latest data suggests that with signs of improvement in the manufacturing sector and with higher output prices, while RBI is still expected to cut rates, there is need for a degree of caution.
Pollyanna de Lima, economist at Markit, said, “March’s survey suggests that inflationary pressures in manufacturing are on the upside, with cost burdens rising at the quickest pace in three months and output charge inflation reaching a 16-month high. Falls in commodity and oil prices were offset by the weaker rupee, making imported raw materials costlier. This build-up in inflationary pressures may lead RBI to hold off from cutting rates, especially as solid growth was seen.”
The need for caution will be reinforced by looking at core Consumer Price Index (CPI)-based inflation. Chart 2 shows that while core CPI inflation (ex-food, ex-fuel) has not only been remarkably sticky throughout the past one year, it is also higher now than it was a year ago.
