The Wholesale Price Index (WPI)-based inflation dropped to 6.55 per cent last month from 7.47 per cent in December last year. The decline in the headline inflation rate to its lowest level in 26 months in January has evoked a wide range of reactions.
At one extreme, it seems to heightened the already buoyant mood in the stock markets. The two benchmark indices, the Sensex and the Nifty, have recently been climbing to levels not seen in a long time.
After being in the doldrums for most of 2011 — Indian stock markets were among the worst performers last year — they have, since the beginning of the New Year, been right at the top of foreign institutional investors' preference lists.
Like many things connected with the stock markets, there is no rhyme or reason to explain, leave alone rationalise the behaviour of large investors. Apart from the news on inflation, there is very little in recent macroeconomic data that could spur stock markets at least to the extent seen last week.
The Index of Industrial Production (IIP) for December, 2011, released soon after, does not by any means indicate an industrial recovery. (year-on-year growth in industrial production slumped to just 1.8 per cent).
Although the IIP series are known to be volatile, the December figures reinforce the perception of an industrial slowdown. Certainly that is not something for the stock markets to cheer about.
As far as Indian stock prices are concerned, the possibility of capital flows reversing is real. That should normally suppress any uncalled-for optimism. Moreover, the Union Budget is less than a month away. The pre-budget sentiment in the markets has traditionally been far less upbeat than what it is now. Punters usually hedge their bets ahead of the most important economic news.
The government has been more circumspect in reacting to the inflation data. Finance Minister Pranab Mukherjee was confident that the inflation rate would moderate further in the coming months. He, however, expected the prices of manufactured goods to be more gradual compared with the fall in food prices.
Will the lower inflation figures prompt the RBI to commence the long awaited phase of interest rate reductions? A monetary policy review is due in March and on the face of it, the January inflation figures do improve the odds for a round of monetary easing.
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