CPI up but IIP down! Will RBI go tough on policy rates in June?
May 13, 2014

Impact on RBI policies...
Although IIP growth remains weak, it is unlikely that RBI would lower policy rates to boost growth. RBI has adopted inflation-targeting approach. For the year 2014, retail inflation target has been set at 8%. Retail inflation measured by the movement of Consumer Price Index (CPI) came in at 8.59% for April which is higher than 8.31% recorded in March. Led by higher vegetable prices, food inflation advanced at 9.8% as compared to rise of 9.1% recorded in March. Unseasonal rain and hailstorm in many regions of the country, was expected to affect prices of fruits and vegetables.

PersonalFN believes, going forward, RBI would be watchful to several factors that would pose a threat of pushing the retail inflation up. Falling industrial growth may not be considered a reason for lowering rates if retail inflation stays high. Indian Meteorological Department (IMD) has predicted that rainfall would be 5% lower than its multi-year average this monsoon season, with a possibility of model error of +/- 5%. Although IMD rules out a possibility of getting excess rain this season; it has not yet predicted any significant shortfall in rain. The updated forecast is likely to be issued in June. This may provide more clarity. If RBI sees any upside risk to inflation; it may break its status quo and even consider raising rates. But for now RBI may keep policy rates unchanged.

In addition to these, factors such as policies of new government, fiscal management and approach of the new government in containing inflation would impact the decision making of RBI. Strong policy measures would provide RBI some room to give some incentives to growth.

Impact on equity markets...
At the moment, market is apathetic to any other news other than outcome of Lok Sabha elections. Under normal circumstances or in the absence of any other major event, markets may have reacted negatively to falling industrial production and rising inflation; but for now poll results remains the single biggest event for equity markets. PersonalFN is of the view that if the trend of rising inflation and falling growth continues even under new government, markets may start worrying as they are hopeful that NDA led government, if comes to power, would boost growth.

Impact on debt markets...
More than anything else, inflation and fiscal management of Indian government have been affecting debt markets. Therefore, rising inflation is certainly a negative for Indian debt markets. This is why debt investors haven’t gained much from the positive sentiment that has taken equity markets to a new level. India still struggles on the fiscal deficit front. Moreover, inflation remains sticky. Continuous issuance of long maturity debt may keep yields high as yields on Indian sovereign debt is a function of supply of Indian debt, Sovereign rating of India and yields on government debt of other nations, especially that of the U.S.

It has been seen that, UPA government fell short of achieving revenue targets especially due to shortfall in tax receipts. On this backdrop the new government would look at revising tax laws and implementing Direct Tax Code (DTC) and Goods and Services Tax (GST). Weaker industrial performance puts pressure on achieving aggressive revenue targets.

On the external front, containing Current Account Deficits (CAD) and enhancing forex kitty remain top priorities. Performance of the new government on this front would have an impact on the Indian debt markets as well.

PersonalFN is of the view that, till anything changes on these fronts, it is unlikely that debt markets would be affected in a significant manner. They might just stay responsive to demand-supply dynamics. Having said this, any bad news on the inflation front as well as on fiscal deficit front, may negatively affect Indian debt markets.