Inflation Paradox: Why rural CPI inflation is higher than urban CPI inflation

The main culprit behind the recent increase in India’s CPI inflation is rural India, while the urban CPI inflation has been largely under control. To put things into perspective, consider these facts. Total CPI inflation in November 2014 was 3.3% of which 1.8 percentage points (ppt) were contributed by rural CPI and 1.5 ppt were contributed by urban CPI. From November’s 3.3%, India’s CPI inflation surged to 5.4% in June 2015 led by 3.5 ppt contribution by rural CPI and 1.9 ppt by urban CPI. The contribution of rural CPI inflation has nearly doubled from 1.8 ppt in November 2014 to 3.5 ppt in June 2015 as compared to relatively lower contribution of urban CPI inflation from 1.5 ppt in November 2014 to 1.9 ppt June 2015.

What is more paradoxical here is that rural inflation has nearly doubled since November 2014 at a time when rural demand is going through the worst down cycle in over a decade. Here are four factors that tell the story of rural distress. One, nominal rural wage grew merely at 2.6% in May’15, the slowest pace since June 2005. Moreover, real rural wages have actually witnessed a contraction in nine of the last 10 months. Two, minimum support price (MSP) of agriculture produce grew at 1.6% and 2.9%, respectively in fiscal 2015 and fiscal 2016, the lowest in last 9 years. Three, foodgrain production of rabi crop contracted by 7.2% in 2014-15 over 2013-2014 as unseasonal rains in March 2015 destroyed a significant chunk of standing rabi crop. Four, the rural economy is reeling under negative wealth effect as the land prices in rural areas have fallen by around 20% since the peak of 2013-14.

What is more baffling is that milk inflation in rural India, which is the source of milk supply for the entire country, at 7.9% is 200 bps higher than milk inflation in urban India. Even inflation for cereals in rural India at 2.8% in June 2015 is 240 bps higher than in urban India. A simple logic suggests that pace of price increase should be lower in rural India than in urban India as the latter completely depends on the former for the supply of these items.

Similarly, rural inflation for recreation and amusement category, which includes cost of movie ticket, hotel lodging charges, monthly charges for TV cable charges etc, has gone up from 4.2% in November 2014 to 5.8% in June 2015 while urban inflation for the same category eased from 5.1% to 4% during the same period.

Is data collection a problem? Price data in rural and urban India is collected by two separate bodies. National Sample Survey Office (NSSO) collects price data for urban CPI and Postal Office is responsible for collecting price data for Rural CPI. While data collection is the core function of the former, it is an additional responsibility on the latter. NSSO has employed thousands of qualified field officers from statistics/economics background for the data collection work. On the other hand, price data in rural India is collected by postmen, who obviously are not the best qualified persons for the job and it is plausible to have a doubt on the quality of price data collected by them. Highlighting this issue, a Reuters article had quoted a postman, “Sometimes during the rainy season, I am unable to go out. Then I have no option but to fill in the prices of different items myself, ...usually I go to shops once or twice in two or three months to check price trends and fill in the price details myself by cross-checking with my wife”. The more worrisome part is that these numbers are key ingredients for monetary policy decision-making by the RBI, risking a case of garbage in garbage out.

There is no reason for such a sharp spike in rural inflation to sustain given that rural demand has slipped to a decadal low. Hence, lower rural demand would pull the rural inflation down in coming months.

Outlook on monetary policy: While RBI kept the policy rate on hold on 4 August 15, it is looking for more clarity on impact of monsoon on inflation trajectory and timing of the Fed “lift-off” before easing the repo rate further. Interestingly, RBI has lowered January 2016 inflation projections by 20bp to 6.1%. CPI inflation, however, is likely to be at 5.4% by January 2016 due to likely fall in rural inflation and lower crude oil prices – both are not factored into RBI’s inflation model – providing a 70bp downside to RBI’s inflation projections. Therefore, RBI may prepone another rate cut of 25bp on 29-Sep’15, given uncertainty over many key issues – sequential increase in food prices over the past two months, monsoon in Aug-Sep and fed rate action etc – will be over by then. Moreover, favourable change in some of the key liquidity enhancing factors – improving CAD, change in household savings from physical to financial assets, strong deposit mobilization and low credit off-take – may push liquidity into surplus, leading to reverse repo becoming the operative rate. It could be an effective 100 bps cut in interest rates. Therefore, we may not be close to the end of the easing cycle yet and there is more downside left to the interest rates in India. 

Easing though liquidity route to continue, 100bps cut in repo rate in 2013

Due to high inflation, the RBI today kept the repo and reverse-repo rates unchanged, at 8% and 7% respectively. However, in order to keep liquidity into its comfort zone, RBI cut the cash-reserve ratio (CRR) 25bps, to 4.25% of net demand and time liabilities (NDTL). The move would inject Rs 17,500 cr liquidity into the system. Taking the liquidity route to ease monetary policy, the RBI has cut the CRR by 175bps in last ten months.

The RBI has revised its FY13 GDP forecast downward to 5.8% from 6.5% in Jul ’12 policy. The WPI inflation target for Mar’13 has been revised to 7.5%, from 7% earlier.  Both deposit and non-food credit growth has been revised downward by 100bps to 15% and 16%, respectively.

100bps cut in repo rate in CY13. Given upside risks to inflation till Dec ’12, a rate cut by RBI until Dec’12 is unlikely. I expect the central bank to focus on easing liquidity through open market operations (OMOs) and by slashing cash reserve ratio. I expect WPI inflation to peak out at 8.5% in Dec’12. Likelihood of a bumper rabi crop and strengthening rupee, coupled with a favourable base effect, are key factors which could soften WPI inflation considerably post Dec’12. I expect WPI inflation to soften to 6.1% in Apr’13. Accordingly, I expect 100bps repo rate cut in 2013 with the first cut starting from Feb-Mar ’13. In its guidance, the RBI also said, “the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13”. Until then, the RBI is likely to continue with the liquidity enhancing measures – CRR cuts and OMOs – to support growth.

India’s services sector: The last bastion also under siege

Indian economy has been undergoing a serious economic downturn for last one year. It’s GDP in 1QFY13 grew merely 5.5%, marginally higher than 5.3% in the previous quarter. The bad news is that the services sector, which contributes near 60% of India’s GDP, is getting impacted by the severe slowdown in the manufacturing sector. 



India's services sector facing a tough time 

 

Growth in services sector decelerated sharply to 6.9% in 1QFY13, - the lowest in over three years. The resilient services sector had been the key driver of India’s GDP until now. The services sector recorded a median growth of 10% in the past 29 quarters.

I expect that India’s GDP growth would moderate to 5.8% in FY13. Despite the marked growth slowdown, upside risks on inflation are unlikely to allow RBI to cut repo rate in CY12.

Here we go again!!!

Petrol prices have been hiked by Rs 3.14 a litre due to a sharp 8% depreciation in rupee in last one and a half months. The petrol price hike decision is coming a day before the RBI’s mid-quarter monetary policy meet tomorrow. However, the impact of the petrol price hike on WPI inflation is going to be merely ~7 bp.


I still feel that the RBI should pause this time since the growth outlook (both global and domestic) has drastically changed since the last policy meet on Jul 26. Moreover, the debt crisis in Eurozone has worsened further.

If you remember, during Jun-Jul 2008, the RBI had hiked the rate by 125 bps and within two and a half months it had to cut the rate by 100bps and then by another 50 bps in next twenty days.

So lesson for the RBI: One should learn from ones mistakes.

Indian economy: Growth slowdown or a transitory dip?

Indian economy grew 7.8% in the fourth quarter of FY11 (Apr-Mar), following 8.3% growth in the previous quarter. For full year FY11, GDP grew 8.5% as against 8% during FY10. 

The agriculture sector saw strong growth of 6.6% in QFY11, the highest in last seven years. Ironically, agriculture sector has been a great savor for Indian economic growth in FY11.  Both the major crops (kharif and rabi) have witnessed a bumper production, thanks to a normal monsoon last year. This year also, the monsoon is expected to be normal, increasing the prospects for healthy agriculture production.

Reflecting the impact of the high interest cost, real investment growth decelerated to 2.2% in 4QFY11, the lowest in eight quarters. Moreover, fixed investment grew only 0.4%, down from 7.8% growth in 3QFY11. However, to some extent, a high base is also responsible for the anaemic investment growth figures.

Private consumption growth at 8% in 4QFY11 (8.6% in FY11 versus 7.3% in FY10) continues to be a major driver for FY11 GDP.

Despite ~10% inflation in FY11, private consumption continued to grow at a healthy pace. With softening of inflation in 2HFY12, I expect private consumption to grow at a healthy ~8% pace. Slowdown in investment growth is a concern. However, forward-looking indicators such as acceleration in credit flow to industry (ex infra), sequential improvement in industrial growth and pricing power with manufacturers show likelihood of investment recovery in the second half of FY12. With a normal monsoon and investment recovery in 2H, 8.5% GDP growth looks likely in FY12.

Therefore, according to me, strong private consumption growth, pick in investment and buoyant exports outlook make me believe that the Indian growth story is likely to remain strong and all the long term fundamentals are very much intact.

India’s current a/c deficit narrows on record high software exports

India’s current account deficit (CAD) for 3QFY11 narrowed to US$9.7bn or 2.3% of GDP, against US$12.2bn or 3.5% of GDP a year earlier. Three key reasons behind the improvement in the current account deficit: One, the software services exports in 3QFY11 increased 14.6% to US$14.7bn, the highest ever in a quarter, against US$12.9bn a year ago. Two, workers’ remittances rose 5.2% to US$13.4bn in 3QFY11 from US$12.8bn in the year-ago quarter. Three, A US$2 bn delta came from the non-software services exports. Though the balance of non-software services exports in 3QFY11 were a drag (a US$2.6bn deficit), it has markedly improved from the US$4.7bn deficit of the year-earlier quarter.

On the capital account front, thinghs were not too rosy. The capital account surplus rose only marginally to US$14.9bn in 3QFY11, against US$14.6bn a year ago. While inflows under portfolio investment, external commercial borrowing (ECB) and banking capital gained some traction over 3QFY10, inflows under foreign direct investment (FDI) and short-term trade credits were subdued. Notably, the ECB inflows rose to US$3.6bn in 3QFY11, more than doubled from the same quarter a year earlier.

The current account deficit is likely to narrow further in 4QFY11 for two reasons: (a) high exports growth vs. imports resulting in narrowing of the merchandise trade deficit; (b) higher invisible surplus on buoyant software services exports and strong remittances. However, high international crude oil price, if persists, may pause a threat to the improvement in India’s current account balance. Therefore, the rupee is likely to be on the upward trajectory in the next two quarters. I expect rupee to reach around 43 per dollar by the end of June quarter.

Cost of loan likely to increase further as the RBI up the policy rate

Continuing with its calibrated monetary tightening cycle, the RBI today hiked the repo and reverse repo rates by 25bps each. This is a reaction to the high and sticky inflation, which continues to be nearly double the medium-term target of the RBI since Jan ’10. RBI now projects WPI inflation at 8% by end-Mar ’11.

The repo rate – the rate at which banks borrow from the RBI – now stands at 6.75% and the reverse-repo rate – the rate at which banks park money with the RBI – at 5.75%. Today’s rate hike in the policy rates marks the eighth consecutive hike since Feb ’10. Overall, the RBI has hiked repo rate by 200bps, reverse-repo rate by 250bps and CRR by 100bps in the ongoing rate hike cycle. However, the effective rate hike in the operative rate has been 350bps as the operative rate has changed from reverse repo to repo rate due to change in the liquidity situation.

The RBI has increased WPI inflation projection for end-Mar ’11 to 8% from 7% earlier. WPI inflation inched up, to 8.3% in Feb ’11, after softening to 8.2% in Jan ’11. Notably, the RBI has mentioned that non-food manufactured products inflation continues to be Ill above its medium-term trend – it rose sharply, from 4.8% in Jan ’11 to 6.1% in Feb ’11 – indicating that producers are able to pass on higher input prices to consumers.

What next. The food articles inflation has started considerably softening on account of improved supply and the trend is expected to continue on a likely bumper rabi crop, which will hit the market early next month. The main pressure to inflation, going forward, is likely to come from manufactured products. I expect inflation to remain elevated (7% average) in FY12. I expect the RBI to hike policy rates once more by 25bps each in the next monetary policy meeting on 3 May ’11.

Now, the cost of loans is likely to go up further. Clearly, this negative for the Real estate, auto industry and other interest rate sensitive industries. So, guys, be ready to face a high interest rate environment and plan your expenditure accordingly.

India's central bank takes a breather

The RBI has taken a breather after following the aggressive tightening path since beginning-CY10. As headline inflation has started softening, managing liquidity seems to have become the main focus area for the RBI. We expect further tightening in policy rates, in FY12.

Key policy rates remain unchanged. In line with expectations, the RBI left the repo rate (at which banks borrow from the RBI) and the reverse-repo rate (at which banks park money with the RBI) unchanged, as per its mid-quarter monetary policy review today. The cash reserve ratio (CRR) was kept unchanged at 6%.

Break from policy rate hikes. After six consecutive policy rate hikes since Feb ’10, the RBI has taken a breather. The RBI has hiked repo rate by 150bps, reverse-repo rate by 200bps, and CRR by 100bps since beginning-CY10.

Focus on liquidity. In a bid to address the prevailing acute liquidity shortage in the system, the RBI took two major steps – One, it cut the statutory liquidity ratio (SLR) by 1%, to 24% of net demand and time liabilities (NDTL). This, however, has been counter-balanced by reducing the additional liquidity support under the LAF announced on 28 Nov ’10, to 1% of NDTL from 2%. Two, it announced that it would purchase government securities of `480bn within the next month through the open market operation (OMO).

Liquidity to remain tight. Despite RBI’s measures, we do not expect significant improvement in the liquidity situation in the near term. Post mid-Jan ’11, however, the tight liquidity situation may start easing.

RBI retains broad projections. The RBI has kept the FY11 GDP growth projection at 8.5%. As regards inflation, the RBI has indicated possible upside risk to its Mar ’11 target of 5.5% in the face of rising international commodity prices. WPI inflation considerably softened to 7.5% in Nov ’10, the lowest since Jan ’10.

Policy rate outlook. In line with our estimates of softening of both inflation and real growth rates in 2HFY11, we expect the RBI to maintain policy rates at current levels for remaining-FY11. However, RBI’s medium-term focus is likely to remain biased towards tightening. After softening to ~5.5% levels by Mar ’11, we expect inflation to start inching up post May ’11. Hence, we believe key policy rates would be further tightened by another 75bps in FY12e. Transmission of monetary tightening would keep upward bias for both lending and deposit rates

India moving ahead of peers by adopting hawkish stance on monetary policy

In its first quarterly review of Monetary Policy FY11, the Reserve Bank of India (RBI) hiked the repo rate (the rate at which banks borrow from the RBI) by 25bps to 5.75% and the reverse repo rate (the rate at which banks park funds with the RBI) by 50bps to 4.5%. The 50-bps hike in reverse repo rate was higher than the street expectation (25bps hike in both rates). Since the repo rate is the operating rate in the current liquidity shortage scenario, the 50 bps hike in the reverse repo rate will have only a limited role to play. From the policy document it is clear that the RBI’s focus has shifted to anchoring inflationary expectations in the economy.

Though the RBI seems sanguine on the economic recovery front, it showed deep concerned about the high inflation in the economy. The central bank increased the economic growth forecast for fiscal year 2010-11 to 8.5% from 8% earlier and the year-end inflation target to 6% from 5.5% earlier.

Another important announcement is that the RBI will now undertake mid-quarter reviews roughly at the interval of about one and half months after each quarterly review. Now this is welcome step, given the fact that in recent years, there have been several occasions when the RBI had to take off-cycle policy actions in response to macroeconomic developments. In fact the frequency of the intra policy actions had increased off late. For example, intra policy rate actions were taken in April, June, Sep and Dec in 2008; in Jan and March in 2009; and in March and July in 2010 so far.

On the policy rate outlook, assessing the current scenario, any change in policy rates during the 16 Sep ’10 mid-quarter review is unlikely. However, I expect 25-bps hike in repo and reverse-repo rates in the second quarterly monetary policy review on 2 Nov ’10

Is the recent recovery in the global economy sustainable?

The developed economies like the US, Canada, Japan, Germany, France, S. Korea all have managed to pull out of the so called worst recession in seven decades and have posted quite impressive GDP numbers in last two-three quarters. The two countries which are leading the world economic growth namely China and India have also clocked stellar GDP growths in recent quarters. In addition to that, the US labour market has also shown signs of improvement in last two-three months. Data prints from the US housing market have been quite an icing on the cake in the recent months.

But as we all know that much of it is the outcome of extremely easy monetary policy and gigantic fiscal stimuli launched around the world in last one year and a half. Now the key question at this juncture is that once the policy makers start a gradual exit from the monetary and fiscal stimuli, will the growth momentum sustain? Or the global economy will fall flat once the monetary and fiscal support inevitably withdrawn. And the on-going Europe debt-crisis adds further to the uncertainty to the outlook of the global economy.

Government contribution made all the difference: Government spending has been the key factor behind the strong GDP growth witnessed by major economies in the world. Given the fact that fiscal deficit has increased sharply in most economies in the world, the government support to the economy can not sustain for long. And ultimately the governments will have to withdraw their support which is expected to start in 2010. I, therefore, don’t expect 2010 to be a year of robust economic growth. In fact, according to me India’s GDP growth for FY11 is likely to remain lower than that of FY10. Nevertheless, I expect the macro fundamentals of Indian economy to improve significantly in FY11.

Now talking about the sustainability of the growth momentum, the probability of a double dip recession is very low at this juncture. But the global economy is going to take a while to reach the normalcy level and the global economic recovery process is likely to be rather gradual.

India's GDP growth is more realistic in Dec 09 quarter

India’s GDP grew 6% in 3QFY10, following strong growth of 7.9% in 2QFY10. The number was substantially lower than consensus’ estimates (6.8%). The major surprise came from social and personal services, which declined -2.2% in 3QFY10. If you look at he numbers more closely, you will find that this growth number (6%) is actually better than the previous quarter growth of 7.9%. You must be wondering that this guy has lost it completely. Well, I will just say let the numbers speak to you. Here is the table.

The growth rate of 6% in 3QFY10 seems to be more close to reality than last quarter’s growth rate, which was inflated by government consumption. In 3QFY10, government consumption declined 10.3%, following an increase of 26.9% in 2QFY10. Excluding government consumption, GDP (at constant market prices) grew impressively by 8.5%, as against 4.8% in 2QFY10. That is why I was saying that this quarter growth is better than that of the previous one.

Well this is not it. There are some more interesting points to come. Industry which has 28% weight in the overall GDP, witnessed a strong rebound in 3QFY10. It grew by 11.6%, way ahead of the 7.5% growth average recorded in the past decade. Manufacturing grew a whopping 14.3%, the highest growth in more than a decade.

On the down side, services, having a weight of 56% in the GDP, recorded a decade low growth of 6.3%, dragging down economic growth. Another problem for the economy is its low investment growth. Real investment grew at a tepid rate of 5.1% in 3QFY10. Investment growth continues to be sluggish with a meager 2.4% average growth in the last seven quarters. The investment cycle, however, seems to have bottomed out. Nevertheless, we do not expect a strong recovery in investment before FY12.

The Economic Survey FY10 estimates FY11 GDP growth at 8.2%, which seems quite optimistic. Until India witness a strong recovery in the investment cycle, which was the main driver of growth during FY04-FY08, returning to the 9% kind of growth levels seems unrealistic. Investment growth was around 18% during the FY04-08 period. Furthermore, fourth quarter GDP numbers from many developed economies indicate the fragility of the much-talked-about global recovery.

RBI takes on liquidity

In a rather hawkish move, the RBI increased the cash reserve ratio by 75 basis points to 5.75% in order to address the ongoing liquidity overhang in the system. Other policy rates were left unchanged. The move is expected to drain Rs 360 billion from the system. In the last one month, the overall liquidity in the market has been around Rs 600 to Rs. 800 billion. So factoring in RBI’s rate action, there will still be around Rs 300 billion to Rs 500 billion left in the system.

The comforting factor here is that central government is done with its massive market borrowing programme for the current fiscal. Nevertheless, the move is expected to raise short-term rates and will impact banks negatively. Banks would lose out on account of the increased CRR outgo. Given the current credit demand and deposit growth scenario, it would be difficult for banks to even partially pass-through the same through either a hike in lending or a cut in deposit rates.

As the wholesale price inflation surged to 7.3% in Dec ’09 and the consumer price inflation remains in the teens, the RBI is now focusing more on managing inflationary expectations. The RBI, however, has pointed out that the recovery is yet to fully take hold and that it would require sequenced withdrawal of exit from the current extremely accommodative regime.

To sum up, the recent aggressive tightening in the CRR indicates that the RBI will not take any rate action until the next policy review on 20 April 2010.

Food prices on fire, I see some actions coming from the RBI

At a time when most economies in the world are reeling under deflationary pressure, India stands isolated with intimidating inflationary pressure. And believe me it’s a very dangerous situation when it comes to food inflation in India. I have actually seen my kitchen bill rising like anything every month. I was shocked to see my kitchen bill in Nov 09; it has swollen by around 75% as compared to Mar 09 figures. This is my own experience with mounting inflation in my country. Let’s see what the government’s estimates talk about inflation.

 Primary articles inflation up. For the week ended 28th Nov ’09, the annual rate of inflation for primary articles stood at 13.9% (yoy) against 12.5% for the previous week and 11.6% during the corresponding week last year.

 Food inflation at a decadal high. Inflation for the primary food surged to 19.1%, the highest level in a decade. Food inflation has reached the same level of Dec ’98 when the then ruling National Democratic Alliance (NDA) had lost power at the centre because of high food prices. Therefore, there will be huge pressure on the current government to tame the mounting inflation.

 What’s the outcome? We expect the government to take some measures to rein in high food inflation. But the irony is that the government does not have many options to control food prices. Even if it opts for imports, it is not going to help because international prices of most of the food items are either higher or at par with the domestic prices. It also can not offer highly subsidized food due to tight fiscal situation. Nonetheless, to avoid the political pressure the government should be seen doing something to tackle the high food prices. Thus, we would not be surprised to see some actions coming from the Reserve Bank of India (RBI) earlier than expected. A hike of 50 bps in the cash reserve ratio (CRR) seems imminent. Moreover, the probability of a hike in the repo/reverse repo in the current fiscal has also increased.

Hey Readers 9 Oct '09

Here I am with my views and expectations on the Indian economy once again. This post is coming after a really long time. Well I guess rather than wasting time in this let me get down! (I mean) to writing about the economy.

Macroeconomic indicators show further improvement:

As I have mentioned in my previous posts, the outlook for the Indian economy continue to improve further. And the latest data releases on industrial production, manufacturing PMI and trade come as an eye witness to that. Industrial production has rebounded strongly, as shown in the last two data releases. The IIP recorded healthy growth of 6.8% in Jul ’09, after recording a stellar growth of 8.2% in Jun ’09. The next industrial production data will be released soon on 12 Sep09. I expect the IP growth to be ~ 8% for Aug09 month.

Exports still negative but… Exports growth has been in the negative territory for past nine months on weak global demand. But if we look at the actual levels, foreign trade has already bottomed out in Feb09 as seen in the following graph. On an annual basis also my projections say that positive exports growth is very much in the offing. (Possibly in Sep09)

Agriculture growth remains a cause of concern … but there is a silver lining here also. This year India recorded the worst monsoon season in terms of rain deficiency since 1972, with 24% less rainfall than average. The poor rainfall is going to have an adverse impact on the ‘Kharif ’ crop (summer crop ex. paddy). However, post-monsoon rains could improve the prospects of a better ‘Rabi’ crop (winter crop ex. wheat). Also, the share of ‘Rabi’ crop in the total agri production has been increasing over the years. So if we get a better ‘Rabi’ crop', this will compensate for the loss in the ‘Kharif’ crop. Historically, rainfall has been found to have a strong correlation (0.6%) with agriculture growth.

Overall, India’s growth prospects are quite bright as compared to the developed countries though the poor monsoon has diluted the growth outlook to some extent. What’s your take on it?

PS: In my next post I will try to cover RBI’s take on key interest rate and inflation.

Analysis on the RBI’s monetary policy for 2009-10

The Reserve Bank of India (RBI) left its key policy rates unchanged in its first quarterly review of monetary policy for 2009-10 on July 28th. The repo rate – the rate at which banks borrow money from the RBI – was left unchanged at 4.75%, the reverse repo rate – the rate at which banks lend funds to the RBI – remained at 3.25% and the Cash Reserve Ratio (CRR) - the percentage of deposits that banks keep with the central bank was kept unchanged at 5%. The decision, however, didn’t surprise the market at all for its obviousness. The RBI had reduced the repo rate six times, amounting 425 basis points since Oct’08 in order to ensure enough liquidity in the system. As the liquidity situation has been quite comfortable for last 5-6 months and the inflation seems to be posing a threat in the second half of the current fiscal year, RBI’s decision of maintaining a status quo is completely plausible.

* With upward bias, ** end March

Growth outlook:
The RBI looked more sanguine about the domestic growth outlook yesterday than the last policy review in Apr’09. According the policy document, the business outlook in the country has turned positive signaling a revival of industrial activity. However, the RBI expects the export demand to continue to remain weak in coming months and the services sector may experience the drag of sluggish external demand and the lagged adverse impact of the weak industrial growth. Also, the below normal monsoon this year is likely to pull down the agriculture production for the Kharif season crop. Weighing all these factors, the RBI’s the growth projection for GDP for 2009-10 is placed at ‘6% with an upward bias’. I fee the RBI has been a tad conservative about the GDP forecast. As the recent macro-data points to a better economic environment, the economy is likely to grow at 6.5% in 2009-10.

Inflation outlook:
On inflation front, RBI expects the annual inflation to go up to 5% by the end of March 2010. It says that the WPI-based inflation, which has slipped below zero, has only statistical significance and doesn’t reflect a contraction in demand and may not persist beyond a few more months. However, it expressed concern about the elevated food inflation and an uncertain monsoon outlook could further accentuate the problem.

Regarding the money supply growth, the RBI projects the M3 money supply to grow at 18% during 2009-10. Furthermore, the bank deposit and the bank credit are projected to be growing at 19% and 20% respectively in 2009-10.

But I see the RBI will be having a bigger responsibility this time. As the fiscal deficit has been estimated at 6.8% of the GDP in 2009-10, the government plans to withdraw Rs 4.5 trn from the market in the current financial year. This has hardened the interest rate in the bond market. At the same time the RBI will have to ensure that there is enough liquidity left in the system so that the private sector also has easy access to the funds. But if the government goes little aggressive on the disinvestment plans, the situation could improve significantly with foreign money flowing into the economy.

Outlook for Rupee:
The RBI’s decision of keeping the policy rates unchanged doesn’t seem to have much impact on the rupee. However, a revival in FII inflows and an improved domestic growth outlook are likely to provide a support to the rupee in the coming months. Risk aversion is also expected to subside on possible global economic recovery towards the end of 2009. Therefore, I expect the rupee to inch towards 46.50-47 levels by end of Mar 2010. In the immediate term, however, rupee could continue taking cues from the direction of domestic equity markets and from the dollar’s movement against other major currencies.

To sum up the whole thing, I would like to add that the nine-month long easing cycle of the interest rate seems to have come to an end and the RBI’s next move will be to increase the key rates which might happen as soon as beginning of 2010.

Slowdown in credit off-take in India

Credit off-take has been rapidly slowing down in India since June’08, mainly because of high interest rates (until Oct’08) and banks unwillingness to lend later on. Though the RBI – the central bank of India - has projected 20% growth in the credit off-take for the fiscal year 2009-10, credit growth has slowed down to merely 16.7% in the first quarter of FY10, down from 25% in the same period last year.

But there is some positive news which has come up today regarding the credit off-take in India. The total credit off-take increased 16.3% (y/y) as of 3rd July’09, higher than the 15.1% in the previous fortnight. However, it’s still far below the peak of nearly 30% in Oct’08. But a high base effect is also playing its role in distorting these numbers. Not a problem. Let’s take a look at the monthly growth rates, which could give more insights in the current situation.
Banks' credit growth rate in India

Source: Nomura, CEIC

Well, looking at the monthly growth rates, credit growth seems to be gradually gaining traction; credit growth rose to 1.2% (m/m, s.a.) in June’09, as compared to 0.3% in the beginning of 2009.
Banks have become very reluctant to lend money post Lehman Brothers collapse. They rather prefer putting money with the RBI. There has been excess liquidity in the system for last seven months now, which can be seen by repo liquidity data (see the graph below).

To stop that, the RBI has reduced the reverse repo rate – the interest money banks get for parking their funds with RBI – to 3.25% in April’09, from 6% last year. But the result is yet to be seen. The RBI should take some steps to ensure easy access to funds if it wants to see the country growing at a higher pace. The central bank is going to decide on its interest rate on July 28. Till then, take a chill pill and start snoring.

India Budget 2009-10 spoils the party

I am not enjoying writing this post. Why? Actually, I along with millions of Indian citizens was expecting so much from this budget . Alas ! it fails to deliver completely. That's why I didn't feel like writing about it. But we can't ignore it either. First have a look at the highlights and my comments.

Highlights of the budget

(Fiscal year: April 1 – March 31)

§ Real GDP growth assumed at 6.5% in fiscal year 2009-10 – Quite realistic

§ Fiscal deficit projected at 6.8 % of GDP – No roadmap for fiscal consolidation

§ Total expenditure increased by 36 % to Rs 10,208.38 bn over 2008-09 – Govt will have to borrow from markets, leading to upward pressure on interest rates

§ Allocation for the National Highway Development Programme (NHDP) increased 23% in 2009-10. Also, allocation for Bharat Nirman increased 45% in 2009-10 - Infrastructure gets a focus

§ Allocation under National Rural Employment Guarantee Scheme (NREGS) increased by 144 % to Rs 391 bn in 2009-10 – NREGS has been quite successful in the past and will provide further support to the poor

§ Unique Identification Authority of India (UIDAI) to set up online data base for Indian residents and provision of Rs 1.2 bn made for this in the budget – a welcome step

§ No change in corporate tax rate – No relief to corporate India

§ Fringe benefit tax (FBT) to be abolished – Will provide immense relief to millions of people

§ Commodity transaction tax (CTT) to be removed

§ Minimum alternate tax (MAT) to be increased from 10% to 15% of book profits

§ Raised the exemption limit of personal income tax by Rs 10,000 for all categories of individual taxpayers; by Rs 15,000 for senior citizens. Also, surcharge of 10% eliminated on personal income tax – people will have more money to spend

Finance minister Mr. Pranab Mukherjee disappointed the country by presenting a very ordinary (or call it hopeless) budget on July 6. The whole country was waiting for this event desperately; more so because the Congress had received a renewed mandate following the general election in May09. The newly elected government was expected to bring some revolutionary reforms to set the country on a higher growth trajectory. Nothing of this sort happened. On the contrary, there was no clear road-map on how the government is going to tackle the high fiscal deficit, which has been projected at 6.8% of GDP in FY10. Here are the key numbers from the budget.

But don’t get too disheartened. Budget is not the only platform to declare all the reformatory actions. The government might declare some more actions whenever it gets ready for them. Think positive!!

A silver lining in the cloud!

Indian exports continue to be on a falling spree. Exports declined 29.2% (y/y) in May’09 to $11 bn, after dropping 33.2% in Apr’09 due to weak global demand. This was the eighth straight month when exports have fallen sharply.

The Rupee is likely to appreciate in the coming months (see my previous post on rupee), which in turn will make exports less competitive in the international markets. Therefore, the road from here is not going to be smooth for the exporters. However, the government may unveil relief measures in the coming budget on July 6 to help exporters survive. There are expectations that the government may announce a foreign trade policy in Aug’09 to provide further support to the exporters.

Well, this is not all too bad. There is a silver lining here. Indian imports are also falling continuously for past six months at the same time. Imports fell 39.2% (y/y) in May’09 to $16.2 bn, following 36.6% drop in Apr’09. As a result, India’s trade deficit has halved to $5.2 bn in May’09, as compared to $11.2 bn a year ago. A shrinking trade deficit comes as good news for the economy. Don't you think so?

Outlook for INR/USD

The Indian Rupee (INR) has been extremely volatile in last two years. The currency has touched its peak and trough vis-à-vis the US dollar (USD) in these two years (see the graph below). During the same time, the INR defeated the forecasts made by most of the top notch global & Indian banks. I still remember when rupee was trading around 40 per dollar in Jan’08, few big agencies were betting on the INR going below 30 per dollar by end-2008. This was one extreme though. But most of the agencies were of the view that the INR will keep appreciating though out the year (2008). It didn’t happen. On the contrary, the INR depreciated around 20% to 50 per dollar in the same year. The other extreme was when these agencies were forecasting the INR to touch 57 per dollar merely four months back. So I assume you understood the plight of the forecasters.

What went wrong?

The rupee depends very heavily on Foreign Institutional Investor (FII) flows. If FIIs start sending money to Indian financial markets, the currency appreciates and if FIIs pull out money from India, rupee starts taking a hit.

Rupee dependence on FII flows

Forecasters were very bullish on India’s growth story in the beginning of 2008 and were anticipating heavy FII inflows. But FIIs actually pulled out $9.3 billion from Indian markets in 2008. Due to these heavy capital outflows the INR tumbled to around 50-levels against the USD in Dec' 08.

The way forward

The rupee appreciated very sharply around 47-levels against the dollar following the general election results on May 16. A surge in FII inflows fuelled the INR rally against the greenback. However, the rupee has lost over 2% in last fortnight and is trading at around 48-levels against the dollar.

Economic outlook for India has improved to some extent in last one month. The industrial production data, core sector data, manufacturing PMI, and GDP data are the ones which paint a positive outlook for India. The IIP expanded 1.4% (y/y) in Apr09, after remaining in the negative territory for two months. The core sector posted a growth of 4.3% (y/y) in the same month. Manufacturing PMI expanded for a second straight month in May09 to its highest in last eight months. Moreover, as I have mentioned in my previous post, the World Bank has upwardly revised its India’s GDP forecast for 2009 & 2010 on June 22. The next major event is the fiscal bill, which will be presented on July 6.

A better growth prospect will lead to higher capital inflows in the coming months. This builds up a case for a stronger rupee in the medium-term. Therefore, the rupee is expected to be around 46-levels against the dollar by Mar 2010. However, in the immediate term, the rupee could trade in a volatile range, tracking the developments in the equity markets and also the performance of the dollar vis-à-vis other currencies.

World Bank: India to grow faster than China in 2010

I was glad to see the World Bank’s latest revisions in its global GDP forecasts on June 22, 2009. Now you must be thinking that I have lost it completely because in that update the World Bank actually revised the global GDP forecasts downward for both 2009 & 10. So why would someone be happy about it? Well, I understand your point. But if you have read my older post on ‘Who will be the next global economic growth leader?’ posted on June 17, 2009, I had written that India will leave China behind in terms of economic growth to become the global growth leader.

Five days later the World Bank comes to support my statement by projecting India to grow faster than China in 2010. According to World Bank India would grow at 8% in 2010, making it the fastest-growing economy in the world. China is projected to grow at 7.7% in the same year. Have a look at the following table.

Let’s talk about the world economy now. Despite the recent signs of improvement in some parts of the world, the prospects for the global economy remain quite uncertain. According to the World Bank’s revised forecasts, the world GDP will contract by 2.9% in 2009 as compared to 1.7% it had forecast just two months and a half ago. To my mind, the global economy will take some time - say four more quarters - to come out of the trauma of recession.

The policy makers will have to be extra careful about all macro indicators and will have to respond to them accordingly. Structural imbalances which have been created over the period need to be tackled now. The US consumers need to learn how to save and the Chinese consumers should learn how to spend. Another major problem for many countries is the mounting fiscal deficit, which is going to take the centre stage once the recovery starts. Inflation, unemployment, protectionism… It will be quite a task for policymakers to tackle these-going-to-be-serious issues. Well, I am also bracing myself for bringing all the actions on the economy front to your notice.