Inflation eases to 4.7% in May but rate cut could be elusive

The headline inflation slowed for a fourth straight month in May to 4.7 per cent from a year earlier, but a slump in the rupee is likely to prevent the RBI from lowering policy rates on Monday despite the economy slowing to a decade-low level.

May's reading, the lowest in more than three years, was less than the 4.87 per cent estimated by analysts in a Reuters poll. The wholesale price index, India's main inflation measure, rose an annual 4.89 per cent in April.

The reading for March was revised to 5.65 per cent from 5.96 per cent, data released by the Ministry of Commerce and Industry on Friday showed.

Easing inflation fails to bolster India rate cut hopes as Asian markets roil

Softening headline inflation alone will no longer be enough to spur the Reserve Bank of India to cut interest rates at a time when it faces other pressing challenges such as a record low rupee and the risk of potentially destabilising capital outflows.

The RBI is due to review monetary policy on Monday, facing the same strains erupting across much of Asia as financial markets are looking shaky even as policymakers continue to struggle with cooling economic growth.

Yet India faces its own unique challenges, given consumer inflation remains elevated while a current account deficit that hit a record high of 6.7 per cent in the October-December quarter continues to weigh on the rupee.

That is bound to make traditionally cautious RBI even more reluctant to cut the repo rate again after easing in each of its three previous reviews.

"They (the RBI) have their eyes set on multiple goalposts," said Radhika Rao, economist with DBS Bank in Singapore, while citing other factors such as the government's fiscal deficits.

"The combination of these factors lower the odds for a rate cut on Monday."

The wholesale price index rose by a slightly less-than-expected 4.7 per cent in May from a year earlier, according to data on Friday, showing inflation has fallen within the RBI's comfort zone of 5 per cent for a second consecutive month.

Only two weeks ago, the data would likely have fueled hopes the RBI would cut interest rates again.

Not anymore.

A Reuters poll conducted on Thursday showed that 28 of 38 analysts expect the RBI to hold its rate steady at the June policy review.

That expected caution comes as fears of a tapering in US stimulus spending has exposed India's vulnerability to flows of foreign money. It is one of the few Asian countries besides Indonesia to run a current account deficit.

That has hit the rupee, which touched a record low of 58.98 on Tuesday, and has shed more than 7 per cent since May to become the worst performer among emerging market currencies after the South African rand.

The rupee falls have been exacerbated after foreign investors sold a net $3.8 billion of Indian debt over the past 16 consecutive sessions. The weak currency and outflows could further aggravate concerns about the current account deficit, creating a potentially worrisome feedback loop.

"More than anything else, the rupee's sharp fall could be the most important factor that could work in favour of no rate cut," said Gaurav Kapur, senior economist at Royal Bank of Scotland.

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