Headline inflation eases to five-month low of 6.16% in December, RBI may maintain policy rates

India's headline inflation eased to a five-month low in December on lower vegetable prices, providing some relief to the ruling coalition before a national election and increasing the odds that interest rates will stay on hold this month.

The Congress party is struggling to win back voters but is grappling with its worst economic slowdown in a decade amid surging food prices that have largely affected the country's rural poor.

The wholesale price index (WPI), India's main inflation indicator, climbed an annual 6.16 per cent last month, its slowest pace since July 2013. The reading compared with a 7.00 per cent rise predicted by economists in a Reuters' poll. Wholesale prices had increased 7.52 per cent on year in November - their fastest clip in 14 months.

The pace of gains in December was tempered by a softening in vegetable prices that fell nearly 30 per cent from November, bringing down overall food inflation for the month to 13.68 per cent from 19.93 per cent a month ago.

Wednesday's WPI data follows an easing in consumer inflation that slowed to a three-month low of 9.87 per cent last month after vegetable prices dropped nearly 19 per cent from November.

The latest inflation numbers are expected to give the Reserve Bank of India (RBI) some leeway to keep interest rates on hold at its upcoming policy meeting on January 28.

"The WPI data has surprised on the downside and seen in conjunction with the CPI (consumer price index) data should strengthen the case for a rate pause in the Jan review," said A. Prasanna, an economist at ICICI Securities primary dealership Ltd.

Indian bonds as well as interest rate-sensitive shares rallied after the WPI data. The benchmark 10-year bond yield fell 5 basis points to 8.63 per cent from levels before the data. The benchmark 5-year swap rate and the 1-year rate each fell 4 basis points, dealers said.

Vegetable prices

Wholesale prices for vegetables had surged 116 per cent between March and November, resulting in a drubbing for the ruling Congress party in recent state elections.

Cooling prices will bring some relief to the party as it heads into national elections due by May, seeking a third term. Most opinion polls are predicting heavy losses for the party, in part due to its failure to control inflation.

Persistently high inflation in Asia's third-largest economy is pressuring household budgets and company profits, hitting consumer demand as well as corporate investments.

After raising interest rates twice since September, the RBI left rates steady last month, ignoring high inflation readings as it feared aggressive rate hikes could be damaging for a weak economy.

A surprise contraction in industrial production in November and a slowdown in merchandise exports growth last month suggest the central bank's growth concerns were not out of place.

But what could worry new RBI chief Raghuram Rajan is a pick up in core WPI inflation, which inched up to around 2.8 per cent last month from 2.66 per cent in November. Already, core CPI inflation is hovering around 8 per cent for the past three months, a level Rajan deems as uncomfortably high.

"The moderating headline retail and wholesale inflation has definitely increased the likelihood of RBI maintaing a status quo in its January meeting," said Upasna Bhardwaj, an economist at ING Vysya Bank.

"However, with core inflation inching up, we believe RBI will continue to sound hawkish and hence do not rule out another 25 bps of rate hike in the next few months."

Soaring food prices are primarily responsible for India's long struggle with inflation. While the drought of 2009/10 flared up food inflation, good rains in the following years failed to cool prices.

Since then food inflation has been steadfast around double-digit levels, leading to demands for higher wages, which in turn have raised costs for companies.

Stubbornly high food prices are also chipping away at support for the Congress party as they mostly hurt the poor and low-income groups - the main voters for the grand old party.

In a bid to win back voters, the party has instructed its state governments to do away with middlemen in the sale of fruits and vegetables as part of its plan to stem price rise.

But its inflation fight is largely hobbled by its own welfare policies such as subsidised government purchases of grains that has not let food prices fall below a certain level.

Subsidised purchases of grains such as wheat and rice have also priced out vegetable cultivation, rendering the economy more prone to supply shocks.

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