With the Reserve Bank of India (RBI) slashing its inflation forecasts, which in any case have been way out of sync with actual prices for a long time now, it was with good reason that both stocks and bonds rallied on Thursday.
With the Reserve Bank of India (RBI) slashing its inflation forecasts, which in any case have been way out of sync with actual prices for a long time now, it was with good reason that both stocks and bonds rallied on Thursday. The revised inflation trajectory—4.7-5.1% in H1FY19 and 4.4% in H2FY19—is a big downward revision and rules out any more tightening for the time being. While the central bank’s softer stance is warranted, it does not hold out promise of a cut in the repo rate at the June policy, or even in August. If the monsoon turns out to be a favourable one and oil prices behave themselves, there could be a cut in October, or just ahead of the festive season. Among the risks to the inflation projection that the RBI governor has flagged, the biggest is probably the impact of the hike in the minimum support prices, where, as the governor has pointed out, there is no clarity yet. While the government may not spend a fortune on the scheme, in a pre-election year, it would certainly make sure the outlay is not insignificant. There are no doubt factors that could stoke inflation: the governor also talked of a possible slippage in the fiscal deficit and also the impact of increases in the state government-led house rent allowances. Also, if growth picks up further, the increase in input costs, as also selling prices, could spill over from Q4FY18 to the next fiscal. Nonetheless, the governor’s projection of an H1FY19 inflation trajectory, which is lower than anticipated earlier despite a likely rise in food prices in H1FY19, could be spot on. What could queer the pitch is some shortage in liquidity, not immediately but later in the year. It is true the central government will borrow just under 49% of its total FY19 target in the first half of the year, unlike in previous years when the borrowing has been up-fronted. Moreover, while demand for credit has picked up in the past couple of months—the increase coming off a favourable base, no big upsurge in demand is expected. However, banks are in the process of replacing non-bank funding from their overseas branches with rupee loans since LoUs have been disallowed and, by some estimates, the amounts required could be around Rs 35,000 to Rs 40,000 crore. Also, how much support liquidity would get from the RBI’s forex market interventions is not clear. That is one reason bond yields are unlikely to stay below 7% for a sustained period if they fall to those levels; already, they have retraced from a high of 7.78% in March all the way to 7.13% on Thursday. In effect, although the RBI may have turned dovish there is no good news yet for either companies or individuals, because loans are not about to get cheaper in a hurry. On the contrary, with deposits growing at a fairly slow pace, and savers moving money to mutual funds, banks have been forced to raise interest rates on deposits. So, while they may not hike rates on loans, as some banks have done, no trimming is likely for some time. Under the circumstances, a GDP growth of 7.4% in FY19, over the 6.6% in FY18, looks optimistic.