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17
May 2018
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Inflation (The Total Investment & Insurance Solutions)
“We
expect the RBI (Reserve Bank of India) to keep policy rates on hold at its
meeting in June, but shift to a hawkish tone,” says Goldman Sachs in a research
note. Although better activity data, higher inflation, and rising crude oil
prices all point towards a more hawkish RBI and could warrant a policy rate
hike, Goldman Sachs thinks that the RBI would await clarity on minimum
support price (MSP) hikes for summer crops, monsoon outturns, and more
inflation data before embarking on a rate hiking cycle. The Total Investment & Insurance Solutions
Goldman
Sachs thinks that the decision facing the RBI is quite close. Its RBI probit
model suggests a 30% probability of a rate hike. The policy projection is given
in the chart below: The Total Investment
& Insurance Solutions
 |
RBIThe Total Investment & Insurance Solutions)
“We
maintain our view that the RBI will likely begin hiking policy rates in August
this year. The probability of a June hike would increase if international oil
prices rise further, or the Indian rupee depreciates significantly ahead of the
June meeting,” forecasts the research note.
Goldman
Sachs enlists the following reasons in its analysis for its anticipated hawkish
tone from RBI: The Total Investment & Insurance
Solutions
(a)
India’s activity growth data have been gradually improving over the past few
months. The Current Activity Indicator (CAI) suggests that India’s economy grew
by 8.3% year-over-year in April 2018. Growth has remained above the 8%-mark for
four consecutive months for the first time in seven years. The growth recovery
was broad-based across the rural and urban economy, although the former is
growing at a slower pace. The Rural CAI accelerated to 5.4% yoy (year-on-year)
in April 2018, led by a pickup in both consumption (two-wheeler sales), and
investment (tractor sales) indicators. Urban economic growth has consistently
grown over 9% yoy over the past few months, driven by a pickup in
investment-related indicators (manufacturing PMI, commercial vehicle sales, industrial
production, etc.). Urban consumption growth is yet to see a meaningful pickup
according to our CAI. The shocks from demonetisation and GST implementation
appear to be fading. The key downside surprise this year has been the
development in the banking sector (Punjab National Bank fraud,
higher-than-expected haircuts on existing non-performing loans etc.), which led
Goldman Sachs analysts to reduce their FY19 real GDP growth forecast by 40bp
(basis points) earlier this year. Goldman Sachs analysts continue to think that
the bank recapitalisation program will help kickstart a powerful positive
impulse between credit and investment growth, boosting overall activity growth
in the second half of the fiscal year 2018-19. The Total Investment & Insurance Solutions
(b)
Headline inflation has bottomed and will likely rise over the coming months.
Headline inflation had moderated to 4.3% yoy in March 2018 from 5.2% in
December 2017, leading the RBI to lower its headline inflation forecasts by
40-50bp at its April monetary policy meeting. Since then, April headline
inflation has surprised to the upside, coming in at 4.6% year-over-year, with
core ex-transportation and communication inflation breaching the upper-end of
the RBI’s inflation target band. This is likely to warrant a more hawkish RBI.
The recent spike in oil prices following the withdrawal of the US from the Iran
nuclear deal poses additional upside risks to India’s headline inflation
forecasts. Goldman Sachs analysts estimate that a 10% increase in crude oil
prices leads headline inflation to rise by 10bp (the impact increases to +25bp
including second-round effects). The Total
Investment & Insurance Solutions
The
inflation forecast for the rest of the year is given in the chart below:
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| RBIThe Total Investment & Insurance Solutions) |
(c)
The rise in international crude oil price poses risks to India’s current
account deficit. Tightening of global financial conditions have prompted
several central banks across the region (particularly the current account
deficit countries) to normalise monetary policy – with Philippines hiking most
recently, and chances of a hike in Indonesia rising, argue Goldman Sachs
analysts.
For
these reasons, Goldman Sachs analysts forecast a hawkish tilt in the central
bank’s tone at the June meeting, although they do not expect the central bank
to hike policy rates given a number of uncertainties still prevail: the
government is expected to announce minimum support prices for summer crops in
mid-June; July-September is the key rainfall season for India, which eventually
determines food production (and consequently food prices) for the upcoming
year; and fiscal slippage concerns are likely to exert upward pressures on
inflation which need to be carefully watched. The Total Investment & Insurance Solutions
The
research note suggests tighter monetary policy over the next couple of years,
rising nearly 200bp from current policy rates. RBI is expected to hike interest
rates cumulatively by 75bp by Q2 2019, with the risks of more in the
second-half of 2019 depending on trends in growth recovery and inflation
expectations.The Total Investment & Insurance
Solutions
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