One of the lesser known works of Shakespeare is ‘All’s Well That Ends Well’. This comic treatise is currently lending headline support to sentiment in the bond market.
One of the lesser known works of Shakespeare is ‘All’s Well That Ends Well’. This comic treatise is currently lending headline support to sentiment in the bond market. Just a few months back, the bond market was reeling under pressure from fiscal slippage spillovers along with hardening of global crude oil prices and US interest rates. This juxtaposed with RBI’s projected trajectory of substantially higher inflation in February policy review along with inter MPC balance tilting towards a rate hike spooked market participants. However, over the last few weeks, things have started to turn favourable bit by bit. First, came the pruning of FY19 G-sec borrowing target by `500 bn. This was soon followed by the regulatory dispensation allowed to banks to smoothen provisions against trading losses incurred in Q3-Q4 FY18. Last, but not the least, is the support from monetary policy. While the MPC maintained status quo in its first bi-monthly review for FY19 — a decision, on expected lines — its neutral policy undertone was laced with signs of dovishness. At the headline level, the RBI revised lower its CPI inflation projection for H1 FY19 to 4.7-5.1% from 5.1-5.6% provided earlier in February. Similarly, the projection for H2 FY19 was pruned to 4.4% from 4.5-4.6%. In a nutshell, the projected average CPI inflation for FY19 stands revised at 4.7% vis-à-vis 5.0% earlier. If one were to exclude the ongoing impact of HRA adjustments on account of the implementation of the 7th Pay Commission then the projected average CPI inflation for FY19 moderates further to 4.5%.
While it would be tempting to allude the sharp correction in vegetable prices in the last two months as a major factor behind the revisions, the drivers could lie somewhere else in my opinion, as vegetable prices are infamous for their volatility and are bound to mean revert in the upcoming summer months. First and the foremost is the surprise waning in sequential momentum in the housing component of the CPI basket, which was under pressure from HRA adjustments between Jul-Dec 2017. However, from Jan-18 onwards, the sequential strength in the housing index is losing momentum, which could be a manifestation of the semi annual adjustment in the CSO’s sample. Second, is the availability of preliminary information of a likely normal monsoon outturn in 2018. Private weather forecaster Skymet has corroborated signals from the Australian Weather Bureau and has projected 100% precipitation (with an error margin of +/-5%) with respect to the long period average. This is likely to assuage concerns regarding a buildup of monsoon related food price pressures in H2 FY19. Third, is the looming threat of an escalation of global trade war. Recent tariff measures announced by the US have evoked a retaliatory reaction from China.
Possibility of deterioration in global trade activity could impart a disinflationary impulse to the world economy (barring US). Fourth, is the easing of generalised price pressures. Analysis of item wise granularity on CPI indicates that 68% of the reported items were having annualised inflation running higher than the headline CPI inflation in Q1 FY18. This proportion moderated sequentially to 59% in Q2, followed by 42% in Q3. For Jan-Mar FY18, it eased further to 39%. This sequential decline highlights the lack of broad based price pressures in the economy. The emergence of these four factors in the last few months could very well offset some of the upside risks to inflation from higher global crude oil prices, fiscal slippages , and narrowing of output gap. The bond market downplayed the single rate hike vote, while regaling under RBI’s growing comfort on inflation. While the market is likely to price out expectations of a rate hike in FY19, basis the policy commentary, all eyes will now be on the MPC minutes to be released later, perhaps with a slightly different script. The imminent rate hike fear has abated.. at least for now.
The writer is chief economist, Yes Bank