Rising inflation vs slowing growth

Published: November 27, 2019 12:34:57 AM

Real GVA growth should decelerate to 4.7% in the September quarter from even June’s 4.9% on November 29.

rbi, reserve bank of indiaThe case for RBI easing is strengthened by the fact that real lending rates are still rising

Indranil Sen Gupta and Aastha Gudwani

Incoming data show that onion prices have spiked to 159%, from 119% in October. Higher onion prices aggravate the base effect of inflation, dipping to 2.3% in November 2018 from 3.3% in October. On balance, we advise investors to look through higher CPI inflation as it is driven by a temporary onion price spike and base effects. We continue to expect the RBI MPC to cut policy rates by 25bps on December 5 (and 15bps in February), with growth slipping on rising real lending rates. Real GVA growth should decelerate to 4.7% in the September quarter from even June’s 4.9% on November 29.

We continue to track November inflation at 5%, up from October’s 4.6% and September’s 4% (see graphic). We see inflation climbing to 4.6% in November-February from 3.3% in April-September. A saving grace is that core inflation ex gold, silver et al remains well controlled at 3.3% in October, actually falling 40bps from September.

This bout of high CPI inflation does not really worry us as it is driven by the base effects of the dip to 2.2% in November 2018-February 2019. This is aggravated by the spike in onion prices with supply delays offsetting the government ban on onion exports as well as trader stock limits . The government has now decided to import 1,50,000 metric tonnes of onions.

We continue to expect the RBI MPC to ease as fundamental drivers of inflation remain in check. A substantial output gap restrains pricing power. Our BofAML India Activity Indicator is pointing to continued slowdown. Second, liquidity remains tight: we estimate excess M3 gap at 1.5%. Third, agflation should be in check as full rivers augur well for coming winter rabi sowing, although the start is delayed by late rains. Fourth, ‘imported’ inflation is muted with recent RBI FX intervention ($24 billion FYTD) limiting depreciation (1.1% FYTD) as well as soft weak world growth holding global commodity prices. Finally, fiscal risks are contained (even after 50bps of GDP slippage BofAMLe).

The case for RBI easing is strengthened by the fact that real lending rates are still rising (see graphic). This has pulled real GVA growth down to 4.7% (4.5% consensus) from even June’s 4.9%. Core WPI inflation has slipped to 0.7% in October from 3.1% last year as weak demand curtails pricing power. Adjusted for this, real lending rates are going up. Although MCLR has fallen 40bps FYTD, on RBI easing, real MCLR has gone up by 120bps. weighted average lending rates (WALR) are actually up 8bps FYTD with tight M3/loan supply slowing the transmission from falling MCLR. Real average lending rates are up 168bps.

Edited excerpts from BofAML 5% inflation vs 4.7% growth: What now? (November 25, 2019)

Sen Gupta is chief India economist and Gudwani is India economist, Bank of America Merrill Lynch. Views are personal

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