UPDATE 2-India's inflation hits 3-yr low, cenbank seen unmoved

Last Updated: Tue, Aug 14, 2012 11:10 hrs

* WPI rises 6.87 pct in July, much lower than expected

* Food, fuel inflation down, but core inflation up

* Inflation not in the comfort zone, govt adviser says

* Drop seen temporary, inflation will rise again - analysts

* Economists doubt inflation will prompt rate cut in Sept

By Manoj Kumar

NEW DELHI, Aug 14 (Reuters) - India's wholesale inflation unexpectedly fell in July to a near three-year low but economists doubt the drop will be enough to persuade the central bank to cut interest rates at its September meeting to try to revive the struggling economy.

Inflation dropped to 6.87 percent in July from 7.25 percent in June as domestic gasoline and vegetable prices fell in July. But global oil prices have been rising since then and drought in some parts of India is threatening fresh inflationary pressures.

In addition, core inflation, which excludes food and fuel prices, rose in July to 5.44 percent from 4.9 percent in June, economists estimated.

These factors will push inflation higher again and make the Reserve Bank of India (RBI) cautious about relaxing its hawkish stance anytime soon, in contrast with central banks elsewhere that are seen easing policy to counter the global economic slowdown, they said.

"There are several risks for the RBI to lose sleep over," said Rajeev Malik, senior economist at CLSA in Singapore. "I think the RBI stays on hold on rates for the remainder of the year."

India's 10-year government bond yield dropped 8 basis points to 8.15 percent after the data, while India's main stock index swung higher after the surprise data. One-year and five-year swaps rates dropped.

Inflation had stayed above 7 percent for two-and-half-years, restraining the central bank from easing monetary policy too aggressively even as the economy slid in the January-March quarter to its weakest pace of annual growth in almost a decade.

It cut its policy rate by 50 basis points in April but has left it on hold at 8.00 percent since. At its last review on July 31, the RBI said cutting rates would "aggravate inflationary impulses without necessarily stimulating growth."

Central Bank Governor Duvvuri Subbarao said then that the rising momentum in core inflation was "disturbing" and he maintained a hawkish tone on Monday, saying inflation was too high.

"This data cannot be taken as evidence that inflation is coming down," said A Prasanna, an economist at ICICI Primary Dealership Ltd in Mumbai.

"We still think it will be premature for the Reserve Bank of India to cut rates."

July's inflation was the lowest since November 2009.

Analysts had expected the wholesale price index (WPI) -- India's benchmark inflation gauge -- to rise in July by 7.37 percent from a year earlier. Only two of 24 respondents in a Reuters poll published on August 8 had expected a reading below 7 percent.

"It is not yet at the level where one can say it has entered the comfort zone," Montek Singh Ahluwalia, deputy chairman of India's planning commission, said of the data.

The pull back came after petrol and vegetable prices fell by nearly 4 percent and 6 percent respectively in July from June.

That pushed annual fuel inflation down dramatically to 5.98 percent in July, its lowest level since December 2009, from 10.27 percent in June. Food inflation eased to just over 10 percent from 10.8 percent.

However, manufacturing inflation rose to 5.58 percent in July from 5.00 percent in June, a major factor driving up core inflation.


Economists said the fall in inflation would be temporary and they expected it to flare up again.

A weak monsoon, which has left India facing drought in some regions, is adding to the inflation threats already present from a weak rupee, which hit a record low in June.

A widespread drought in 2009 forced India to import sugar, pushing global prices to 30-year highs.

Global benchmark Brent crude futures, which fell during most of the March-June quarter, have risen about 25 percent since late June to trade at $114 a barrel.

Sujan Hajra, chief economist of Anand Rathi Securities in Mumbai, said the pipeline price pressures will push inflation back up to 8.5 percent by December.

Shubhada Rao, chief economist at Yes Bank in Mumbai, forecast an inflation rate as high as 8 percent by March 2013. The central bank has predicted inflation of 7 percent by that time.

India's interest rates are among the highest among major emerging economies but the rapid descent in growth has prompted calls for the central bank to cut them at its next policy meeting on Sept. 17.

The central bank has been trying to apply pressure to the government to do more to help revive economic growth, which fell to just 5.3 percent in the January-March quarter from a year earlier, the weakest pace in nine years.

Palaniappan Chidambaram, who took up his third stint as finance minister on July 31, has promised to respond by unplugging supply bottlenecks which contribute to inflationary pressures and arresting a fiscal deficit that puts upward pressure on interest rates.

A failure to check the fiscal deficit, seen reaching 6 percent of GDP in the year to March 2013 and which has prompted two ratings agencies to threaten to downgrade India's credit status to junk, would make it tougher to convince the central bank to try to bolster growth with a rate cut.

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