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As had been increasingly expected
since INR pressures started a month ago, the RBI today kept both
policy rates and reserve requirements (cash reserve ratio) on hold.
The rupee’s sharp depreciation in recent weeks was clearly weighing
on the central bank’s mind because it indicated that the decision
to stay on hold was driven by the “evolving
growth-inflation dynamics…..as well as recent developments in the
external sector”
RBI lobs the growth
ball into the government’s court
On the growth front,
the RBI admitted that growth and macroeconomic conditions remain
weak, “hamstrung by
infrastructure bottlenecks, supply constraints, lackluster domestic
demand and subdued investment sentiment.” That said, the central bank pointed
to some rays of hope referring to a pick-up in consumer on-durables
(as we had highlighted in “The Indian soap
opera: INR stabilizes, Fitch upgrades, IP languishes and CPI
disappoints,”
MorganMarkets, June 12, 2013), the May services PMI and a strong
and timely monsoon thus far.
Yet, the RBI was clear
what it considered to be the main drag on growth, stating that
the “key to
reinvigorating growth is accelerating investment by creating a
conducive environment for private investment, improving project
clearance and leveraging on the crowding-in role of public
investment.”
Sees upside risks to
inflation
The RBI acknowledged
that WPI inflation pressures have moderated meaningfully but in
line with projections. However, it saw “upside pressures
on the way forward from the passthrough of rupee depreciation,
recent increases in administered prices, and persisting imbalances,
especially relating to food, pose risks of second round
effects”
The central bank
clearly has a point. Much is made of global commodity disinflation,
but the rupee depreciation has swamped this. As the accompanying
charts show, measured in local currency, the CRY global commodities
index is the highest in seven month! And, oil prices, are 7% higher
in local currency than a month ago – necessitating a two rupee
petrol price hike over the weekend. The only open question is
whether the pass-through from rupee depreciation to manufacturing
inflation will be lower than previous episodes because pricing
power is weak? But wishing for that is living on a hope and a
prayer.
Rupee, external
sector stabilization key to next rate cut
In its guidance, the
RBI stated the obvious that the policy stance will be determined by
“how growth and
inflation trajectories and the balance of payments situation evolve
in the months ahead.” Yet, it did raise the bar for
future easing by also indicating that “only a durable
receding of inflation will open up the space for monetary policy to
continue to address risks to growth” and further that they would need
to be “vigilant about
global uncertainty, the rapid shift in risk perceptions and its
impact on capital flows”
As we have noted even
before the review, (see, “India: WPI
inflation moderates further but unlikely to induce a rate cut on
Monday,”
MorganMarkets, June 14) we believe the stabilization of the Rupee
and some mean-reversion will be a critical prerequisite for rate
cuts to come back on the table. In addition, the RBI will likely
need to see some evidence that the trade deficit is narrowing, food
inflation is abating, and the risk of passthrough from the FX to
inflation – which could interfere with the “durable” receding of
inflation –is limited.
A rate cut in July
cannot completely be ruled out. The June trade deficit is expected
to narrow substantially and that will help calm nerves. But the
June inflation prints become crucial, because they will reveal
early evidence of any INR passthrough into inflation also what’s
happening to food inflation and therefore headline CPI inflation
from the progress of the monsoon. The most important variable, of
course, is the global environment and whether the Rupee settles
down from here or is subject to more gyrations. If a critical mass
of these variable move favourably and the INR has partially
mean-reverted, the growth-inflation dynamics could yet force a July
cut. But barring a confluence of all these factors, July could well
be an action replay of June.
An ugly May trade
deficit
The only thing more
predictable than the RBI staying on hold was that the May trade
deficit would remain bloated. And the data did not
disappoint.
Recall, the April
deficit had set the cat among the pigeons as it almost doubled to
$17.8 billion from the month before, on surging gold imports,
exports falling-off and non-oil, non-gold imports picking up
pace.
It’s gold
again
May was an
action-replay of April. The deficit surged further to $20.1 billion
on the same dynamics as the previous month. Predictably, the focus
was largely on gold and silver which increased further from $7.5 bn
in April to $8.3 bn in May. The sharp increase over the last two
months is likely a response to the drop-off in global prices and it
is hoped that this constitutes a front-loading
of demand versus
an increase
in demand on account of
lower prices.
To be sure, gold
imports have fallen off sharply over the last few weeks, presumably
as this front-loading has abated and some of the regulatory
tightening measures have kicked in. So gold imports should fall
dramatically in June (the World Gold Council estimates 50 tonnes of
imports in June versus 162 tonnes in May). And this will result in
a gapping-down of the trade deficit this month. Yet, June is also a
seasonally lean month for gold. The test for whether April/May
constituted front-loading versus incremental demand will truly come
when gold is expected to pick-up again in August/September as the
festival season approaches.
But also
disconcerting non- gold dynamics
The exclusive focus on
gold has concealed other disconcerting trade dynamics. Exports
continue to fall-off sequentially, which is surprising given some
pick-up in PMI export orders in recent months. Furthermore, like
last month, non-oil, non-gold imports continues to tick-up
(accounting for $1.8 billion of the 2.3 billion month-on-month
deterioration in May), consistent with the observed pick-up in
consumer non-durables. So the non-oil, non-gold deficit also likely
worsened in May.
For now, however, even
these troubling trade dynamics are not top-of-mind. Instead, Rupee
watchers nervously await the FOMC statement and Bernanke’s press
conference later this week.
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