Economists who were pencilling in 100-125 bps rate cuts a few months ago are now looking at 50-75 bps at best
In this season of roll-backs, it?s interesting to see how quickly estimates for interest rate cuts next year are being rolled back. A few months ago economists were pencilling in cuts of 100-125 basis points, with some convinced the repo rate would hit 7% by March next year from the current 8.5%. But those calculations have been upset and, right now, no one?s willing to wager more than a 75 basis points pruning of the key policy rate with a few less hopeful: the Reserve Bank of India (RBI), they say, won?t be in a position to pare it by more than 50 basis points. One economist has gone so far as to say inflation may turn out to be such a big pain that it?s possible interest rates actually head up sometime later in the year. He has a point; after all, who knows where crude oil prices are headed?
China may have pared growth estimates to 7.5% and much of the eurozone may be heading into a recession but the price of Brent crude oil remains above the $120 per barrel mark. That?s something the central bank reminded us about in its mid-March statement because the impact can be truly devastating, given that India imports three-fourths of its oil needs.
Mercifully, non-food manufactured product inflation is losing pace and could fall below the 5.8% y-o-y seen in February, but the number is not realistic since the higher prices of crude oil haven?t been passed on. Also, the trend could reverse following the 2% hike in excise duties and the 20% hike in railway freight; how much this would add to headline inflation is hard to gauge because companies may choose to absorb some of the costs.
Indeed, the rise in the WPI has, after easing to a two-year low of 6.6% y-o-y in January?a fallout of the lagged effect of monetary tightening, a seasonal fall in food inflation and the favourable effect of last year?s high base?trended up to 7% in February.
The bad news is that the base effect will start wearing thin after April. And suppressed inflation remains a threat since the government continues to dither on increasing prices of diesel, petrol and LPG. At some point it will have no choice but to do so and that will have a cascading impact on prices of virtually everything as will the recent hike in excise and service tax levies. In what is an unexpectedly high number, the Consumer Price Index for February has come in at 8.8% y-o-y versus 7.6% y-o-y in January, and although a new index without too much history, it nonetheless tells us something. That housing prices are climbing at nearly 14% y-o-y can?t be good news nor the fact that the cost of food is up 7% y-o-y in February compared with 4.5% y-o-y in January, thanks to the seasonal impact of vegetables fading out.
RBI is also watching the rupee, which after strengthening to levels of 49 against the dollar, seems to be making its way back to 51 levels. That means the cost of all goods imported, especially crude oil, goes up. One could argue that, in a slowing economy, imports will fall, thereby containing the trade deficit as also the imported inflation. Moreover, strong capital flows into the equity and bond markets could cushion the fall in the rupee; between January and now, flows have totalled some $13 billion and, given that central bankers across the globe are choosing to leave the liquidity taps open, it?s possible money will continue to flow in. But it?s hard to predict when the risk aversion will rise and flows will retrace.
The worry is that the government refuses to become disciplined and is spending way more than it can possibly earn. So revenues are unlikely to grow at 22% estimated in the Budget for 2012-13, because there could be a shortfall in the estimated non-tax receipts of R1.65 lakh crore. On the other hand, the government could overshoot its expenditure target of R15.2 lakh crore because subsidies on food, fuel and fertiliser could cost it more than the budgeted R1.9 lakh crore. In other words, the fiscal deficit could be higher than the targeted 5.1% of GDP; this might not have been such a bad thing had the money been channelled more into investments. But now inflation is likely to remain above 7% through next year and, although that might be much lower than the average of 8.7% this year, it would nonetheless be higher than RBI?s comfort level of 6-6.5%. So while the central bank may have some room to drop policy rates in April, it?s no longer a given the rate cycle will turn decisively. The mere mention of the government?s borrowing target of a net R4.8 lakh crore for 2012-13 has sent the bond markets into a tizzy; Standard Chartered estimates that the yield on the 10-year benchmark will be at 8.5% in March 2013, a little above where it is now. As if that was not enough, there may not be enough money to go around; on a rough reckoning, a 16% growth in deposits would support a 16% loan growth after banks have set aside money for bonds and cash requirement. Banks can, of course, pick up money through tier 2 bonds and so on but it?s interesting that they have started increasing deposit rates. That tells you something about where loans to corporates could be priced. Looks like equities will have some serious competition from fixed income products for a second year running.
shobhana.subramanian@expressindia.com