The economy has received a rare breather from the recent welter of bad news, with government figures showing an unexpected decline in inflation and robust indirect tax collections, although not enough to provide comfort that the worst was over and it would be all hunky dory from here on.

Contrary to expectations of a rise, headline inflation eased to 6.87% in July from 7.25% in June, data released on Tuesday showed, triggering a rally in the stock markets, where the data was viewed as buttressing the case for a cut in interest rates.

Separately, indirect tax collections for July rose 22.2% from a year ago, largely on the back of strong excise collections, seeding hopes that the industrial production figure for July would be better after the 1.8% contraction in June.

But amid all this, a 14.8% decline in July exports - the steepest fall in three years - provided a sobering reality check for the economy, underlining the scale of the challenge the country faces in cranking up its growth engines at a time the global economy is in turmoil.

Increase in Core Inflation Worrying

"The pickup in indirect tax collections was a surprise and might be a result of a drive to push up excise collections while there are clearly major risks going forward for inflation," said Abheek Barua, chief economist at HDFC Bank.
Analysts said they were not hopeful of the decline in inflation sustaining, attributing it to base effect, moderation in fuel inflation and a one-off drop in vegetable inflation.

Fuel inflation showed the sharpest fall at 5.98%, down from 10.27% in the previous month, while food inflation eased to 10.1% from 10.8%.

"While the headline WPI is better than expected, the details of the July inflation print leaves much to worry about," said Taimur Baig and Kaushik Dutta of Deutsche Bank.

One major area of concern is the increase in core inflation, a proxy for demand pressures in the economy, which edged higher to 5.4% from 4.9% in June, reversing the steady decline seen in the last four months.

With international oil prices already on the way up, rising to $115 a barrel from around $90 barely two months ago on hopes of a fresh round of stimulus measures in major economies, and global food production facing challenges because of drought in several countries, experts said it was just a matter of time before the recent declines in fuel and food inflation were reversed.

"Our view (is) that headline WPI inflation will rise above 8% by the end of the year, and we do not see today's positive reading as a reason for RBI to cut rates," Nomura economist Sonal Varma wrote in a note to clients.

RBI, which has of late taken a hawkish line on inflation disregarding calls for rate cuts to prop up a slowing economy, will next revisit its monetary stance on September 17. By then, it would have had another round of data on wholesale and retail inflation along with the all-important first quarter GDP numbers, due on August 31, to decide its stance. Estimates of GDP growth for the first quarter suggest a reading of around 5.5% growth, a slight improvement on the 5.3% growth in the January-March quarter, a nine-year low.

"RBI will wait until next month and look at whether the fall in inflation is sustainable," said Barua of HDFC Bank.
Industry, however, kept up its demand for monetary easing. "With the inflation numbers showing a decline and the global economic environment continuing to be challenging, continued hawkish monetary policy will not serve either the objective of reducing inflation or stimulating growth," said Rajiv Kumar, secretary-general of FICCI.

The 22% rise in indirect tax collections was largely on account of a 27.6% increase in excise tax collections. Service tax collections also rose by a healthy 37.5%, but customs duty collections recorded a relatively muted 8.2% increase, chiming in with the generally poor trade figures.

Imports fell 7.61% to $37.9 billion in July while exports contracted nearly 15% to $22.4 billion, leaving a trade deficit of $15.5 billion. The poor export performance, blamed on poor demand conditions in the US and Europe, means that India would find it difficult to meet its $350-billion export target for the full fiscal year, government officials said.