Home / Market / Mark-to-market /  Normal monsoon, falling inflation, lower interest rates to boost economy

The India Meteorological Department’s (IMD’s) forecast of an above-normal monsoon raises the hope that we could soon see the end of rural distress on the one hand and continue to see low food inflation on the other. Consumer Price Index (CPI)-based inflation for March came in at a six-month low of 4.83% compared with a year ago.

The yield on the 10-year government bond is now at a 32-month low, on these expectations.

True, agriculture is no longer very important for the overall economy, but nonetheless, a good monsoon will give a boost to rural demand as well as ease the problem of water availability that has not only led to rural distress but also affected supply to industries.

As far as inflation is concerned, RBS economist Gaurav Kapur points out that some of the fall is due to the base effect, and while a good monsoon will certainly help contain food prices, it is also a fact that the Reserve Bank of India (RBI) is worried about the effect of the Seventh Pay Commission.

Nevertheless, the good news is that the El Niño weather pattern is fading and a La Niña—which usually results in abundant rainfallis taking its place. True, any interest rate cut by the central bank is likely to take some time, as it weighs the temporal and spatial monsoon impact, the pay commission announcement, and the impact of monetary transmission.

“The government has been proactive in managing food price pressures over the last year despite a weak monsoon. The inflation trajectory was stable as it moved to ~5.0% in March 2016 from 4.9% in April 2015 despite 1.5% lower food grain production with 6.0% lower pulses production. The RBI through FY2016 reduced policy rate by 75 bps (basis points). Hence, attaching too much importance to monsoon for a rate cut cycle is not prudent. However, the normal monsoons will remove a risk factor from the RBI’s dashboard," said a 12 April note from Kotak Economic Research. A basis point is 0.01%.

Higher-than-normal rainfall may help ease pulse price inflation, according to Ritika Mankar Mukherjee, an economist at Ambit Capital Pvt. Ltd.

Second, core CPI, excluding fuel and food, slowed to 4.8% in March, lower than in February. Core inflation may continue to remain weak because of slower gross domestic product growth, added Mukherjee.

Ten-year government securities’ yields have dropped to a 32-month low of 7.42% as of Tuesday’s close, anticipating lower inflation and the prospect of a 25 basis point rate cut by the central bank.

Further softening of yields is contingent on the liquidity situation, which RBI has promised to ease.

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