Brazil and Indonesia, members of the motley crew of BRIIC countries (Brazil, Russia, India, Indonesia, and China), have recently seen their central banks cut policy rates. Consequently, there is some speculation that others may follow suit, including the Reserve Bank of India (RBI). However, this perspective, it would seem, is based heavily on a follow-thy-neighbour assumption and not on country-specific considerations.
Taking an India-centric perspective, there is no need to cut rates but rather a need to tighten. Why? Simple. The inflation problem in India is more severe and, except for maybe Indonesia, the economy is more domestically oriented, leaving it somewhat more insulated against adverse global economic spillovers. While RBI is getting closer to the end of the tightening cycle, we do not think they are quite done yet. Here is why.
Starting with the global economic backdrop, it has not changed much since the last monetary policy meeting in September. One could even argue that it has improved on the margins. Data out of the US has recently been somewhat better than expected, but the same cannot be said for the political stalemate evident from the struggle of Obama’s job plan.
File photo of Reserve Bank of India office in Delhi.
In Europe, there may not have been much improvement on the data front, but the politicians now appear more cognizant of the need for faster and more comprehensive action, although living up to expectations is far from guaranteed.
Turning to India’s economy, developments since the last monetary policy meeting have confirmed the continued moderation in growth and also a broadening of that moderation. For example, the HSBC September PMI readings show that the sequential momentum has slowed notably, with activity in the services sector broadly unchanged in September from the previous month. However, the slowdown is in line with expectations, reflecting the lagged effects of monetary tightening, the uncertainty created by high inflation, and some spillover through the external channel. Also, growth is moderating and not collapsing.
On the inflation front, there has been little relief. Yes, headline and core wholesale price inflation eased a bit in September, but the sequential momentum in inflation held up. Moreover, the September HSBC PMI sub-readings for input and output prices show that underlying inflation pressures remain firmly in place and businesses still have pricing power. Now, this is not surprising considering that the economy comes from a position of excess demand. This means that core inflation pressures will persist for a while even as growth moderates. In addition, it does not help that the currency has depreciated.
What does this boil down to from RBI’s perspective? While the domestic economic slowdown is now more evident and has increased the probability of a pause next week, the lack of relief on the inflation front is likely to see RBI opt to take out further insurance against inflation, tightening by another 25 basis points. This is key to manage inflation expectations and leave monetary policy settings sufficiently contractionary to bring about the slowdown in growth needed to tame the demand-led inflationary pressures in the economy. However, a pause thereafter is quite likely.
Leif Eskesen, chief economist HSBC (India and Asean)
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