India’s inflation slows to two-year low

MUMBAI (MarketWatch) � A drop in food prices helped bring India�s wholesale inflation down to a two-year low in December but economists still don�t expect the Reserve Bank of India to start cutting interest rates this month.

The government on Monday said India�s wholesale price index was up 7.47% in December from the year-earlier month, down from 9.11% in November. The number, which was in line with expectations, marked the first time the rate of inflation fell below 9% in 13 months.

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�Inflation is finally heading down in a substantial way,� said Leif Eskesen, economist for India at HSBC. �But it is too early to claim victory in the fight against high inflation.�

Annual food-price inflation, closely monitored in a country where more than 800 million live on less than $2 a day, fell sharply to 0.7% from 8.5% in November.

But easier year-on-year comparisons played a big role. In 2010, the impact of heavy rains had reduced supplies and caused a spike in food prices. Late last year, supplies returned more or less to normal following a fairly even monsoon season.

Core inflation, which in India measures nonfood manufacturing prices, also fell slightly, to 7.5% annually from 7.8% in November.

But �that�s still way above the RBI�s comfort zone� of about 6.5%, said Rupa Rege Nitsure, an economist at Bank of Baroda. �Consumer demand and consumer-goods production continues to be strong�, keeping upward pressures on prices, she said.

Following 13 rate hikes between March 2010 and December of last year, the central bank said that risks to growth, stemming from the crisis in Europe and slow growth in the U.S., were taking center stage for monetary policy.

The central bank now expects that gross domestic product for the full year ending in March will grow 7.6%, instead of 8% previously forecast.

With weakening growth forecasts and slowing inflation, the market has begun pricing in increased expectations that the RBI will soon start cutting rates, perhaps as early as next week�s monetary policy meeting.

Following the inflation data Monday, the benchmark Sensex IN:1 �rose 0.2% to end at 16,189 on the Bombay Stock Exchange.

But the central bank still has to weigh a number of factors, including a weakening rupee, world energy prices and the crisis in Europe, economists say.

The Indian currency fell sharply last year, lifting the costs of India�s huge import needs, notably oil. And while the crisis in Europe has muddied the investment climate, India�s industrial production showed a strong rebound in November, suggesting demand-led inflation pressures remain in place.

Finance minister Pranab Mukherjee, meanwhile, said in New Delhi Monday he expects the inflation rate to fall to between 6% and 7% by the end of March.

According to Bank of Baroda�s Nitsure, barring other factors that would impact the growth/inflation equation, the RBI isn�t likely to start cutting interest rates until then.