Inflation in India accelerated in August to its highest in over a year, driven by rising prices of food and manufactured goods, reinforcing the case for another rate hike on Friday despite weakening growth and a worsening global outlook.
The wholesale price index, India's main inflation gauge, rose 9.78 per cent in August, higher than the median forecast for a 9.6 per cent rise in a Reuters poll and above the 9.22 per cent recorded for July.
While July industrial output data on Monday was the worst in nearly two years, adding to the argument against a rate increase, the central bank is still expected to raise rates by another 25 basis points at its policy review on Friday as it scrambles to get a grip on inflation.
Expectations for a rate increase are not unanimous, however, with Goldman Sachs among those expecting the Reserve Bank of India to pause in its tightening cycle, after 11 rate increases in 18 months that have lifted the repo rate, the policy lending rate, to 8.00 per cent.
"This does clearly boost scope for the RBI to tighten policy rates by 25 basis points on Friday, though the trajectory thereon could hinge on intermittent inflation outlook, non-manufacturing WPI in particular," said Radhika Rao, economist at Forecast PTE in Singapore.
India's benchmark 10-year bond yield eased 2 basis points to 8.31 per cent while the domestic share market briefly extended losses after the inflation data. Swap rates however were little changed, as the data reaffirmed expectations for another rate increase on Friday.
Rate hike or not, Reserve Bank of India (RBI) Governor Duvvuri Subbarao is widely seen to be nearing the end of a tightening cycle that has made the RBI among the most aggressive central banks anywhere during the uneven global recovery from the financial crisis.
India's headline inflation remains far above the RBI's comfort level of 4 to 4.5 per cent.
Other Asian central banks have been turning dovish as growth in the region weakens amid a darkening outlook for the US and the euro zone, although China's central bank said on Monday that inflation, which fell in August from a three-year peak, was still high and that it would maintain its policy settings.
Manufacturing inflation quickened to 7.79 per cent in August from 7.49 per cent in the previous month, indicating that manufacturers still retain some pricing power, adding to inflationary pressures in the economy.
Analysts say that stripping out the volatile capital goods sector, the index of industrial production (IIP) shows a picture of growth moderation, not collapse.
Demand for consumer goods is still holding up and growth in exports, though down from July levels, is still robust at around 44 per cent while non-food credit growth at more than 20 per cent is still above the targeted 18 per cent.
However, weakening investment demand, industrial slowdown, and bleak global conditions add downside risks to growth. The falling rupee, now trading close to its weakest in two years, could inflate imported price pressures and add to the case for a rate increase on Friday.