Tuesday, January 21, 2014

India Likely to Keep Rates Unchanged

Signs that India's inflation is moderating suggest the central bank will keep monetary policy unchanged at its next meeting but the longer-term case to tighten remains intact.

After the downside surprises in India's wholesale price index (WPI) and
consumer price index (CPI) inflation outcomes last week, odds are high for an on-hold decision by the Reserve Bank of India (RBI) on January 28. Further out, the rate hike cycle has peaked and we expect the benchmark repurchase rate to be held unchanged at 7.75% into the new fiscal year. In the longer term, the bias will still be to tighten rates if the recent drop in inflation proves transitory.

On the fiscal side of the equation, the full-year target is at risk after the April-November 2013 balance amounted to 94% of the full-year target. In this light, the December numbers due by the end of January will be of interest. If one goes by the higher government cash balances with the RBI and some of the news-flow, a cutback in the government spending is already underway.

The government cash balances with the central bank rose to 510 billion rupees by last December and is likely to rise further into the March quarter of 2014. The latter could receive a boost from the need to sharply cut the monthly deficit in the next four months, while second half government borrowings were left unaltered (40% of the full-year borrowings between September 2013 and March 2014). In short, the monthly deficit between December 2013 to March 2014 needs to be cut back to 82 billion rupees in order to meet the annual target, down significantly from the 634 billion rupees in the first eight months. Notably, this trend of high cash balances mimics what occurred between December 2012 to March 2013; also on account of an attempt late in the year, to prevent a breach of the fiscal targets.

In the meantime, the build-up in cash balances is seen as a strain on liquidity conditions and in addition to the regular infusion under the repo, term repo and margin standing facility windows, the government announced open market operations worth 100 billion rupees for Wednesday. In addition, a leading economic daily speculated that a 20% cut in the planned expenditure outlay in the 2014 fiscal year was in the works. The rule that the ministries should spend only a third of their allotment for the March quarter, might also be enforced.

On the revenues end, higher dividend payouts are being sought from public sector companies, along with pushing the divestment process, to provide some relief to collections. Nonetheless, the bulk of the correction to meet the fiscal deficit target will stem from expenditure restraint and the pressure is likely to build in the run up to the elections. Reduction in spending will be negative for the growth outlook this fiscal year, with our estimate at 4.8% for 2014 fiscal year, before inching up to 5.3% in 2015. Rating agencies meanwhile have given the government the benefit of the doubt and shifted focus to post-election growth and fiscal performance.