It is too early to feel comfortable about inflation: Gaurav Kapur
The Reserve Bank of India kept the key rates unchanged in its review of the Monetary Policy on Monday. Gaurav Kapur, senior economist, Royal Bank of Scotland talks to Puneet Wadhwa on his interpretation of the Monetary Policy announcements and the road ahead for the economy. Edited excerpts:
What are your key takeaways from the Reserve Bank of India’s (RBI’s) statements while reviewing the Monetary Policy? What can one now expect from the central bank in the July 31 review?
I am not surprised that the RBI has kept the repo rate unchanged. The case for a rate cut was not a straightforward one given the upside risks to already high inflation. The central bank has once again reiterated its focus on inflation for the time being. It has recognized the limited ability of Monetary Policy to prop up growth, especially considering that higher interest rates have played a relatively small role in the ongoing investment slowdown.
Domestic policy stasis and global investor risk aversion are the key factors behind the stalled investment activity. In the July policy review, the RBI could take a more sympathetic view towards growth and cut the repo rate by 25 bps at least.
The limit of the Export Credit Refinance (ECR) facility for scheduled banks (excluding RRBs) has been enhanced from 15 per cent of the outstanding export credit eligible for refinance to 50 per cent. Does it come as a relief? How do you see the liquidity panning out going ahead?
This measure will have a favourable impact on banking sector liquidity, as higher proportion of INR-based export loans are now eligible for refinancing. Moreover, considering that the CRR is as a quasi monetary instrument, the RBI has refrained from explicitly cutting the CRR given its inflation concerns.
Liquidity is likely to remain in deficit mode considering the pick-up in bank credit vis-à-vis rate of deposit mobilisation. The overall injection by the RBI through the repo window has now stabilized in the range of Rs 800 – 900 billion. Unless there are large capital outflows which in turn squeeze out rupee liquidity further, overall liquidity conditions would tend to improve somewhat with this ECR measure. For more durable liquidity injection, the RBI will continue to use the open market purchase of government bonds.
The Consumer Price Index (CPI) numbers for May have come in at 10.36 per cent as compared to 10.26 per cent (M-o-M). Does this given any degree of comfort given the statements from the RBI today?
It is too early to feel comfortable about inflation in general. The RBI has noted that consumer price inflation and even headline remain higher, even as core inflation has trended lower. The central bank has also noted that upward risks to inflation remain strong. On the whole, the RBI is unlikely to draw too much comfort on the inflation front at this stage. Fiscal consolidation is another aspect, which will be critical for the RBI’s assessment of inflation.
Do you think that the central bank would be able to contain inflation to the desired levels? Have you toned down your estimates of how much the RBI can slash key rates in FY13?
Our outlook for inflation suggests that upside risks to inflation are quiet strong and without a further decline in global crude oil prices and some appreciation in the INR, the RBI will find it difficult to keep inflation within the desired levels. I have not changed my rate cut expectations for FY13. The room for further cuts is limited to 25-50 bps at the most at this juncture.
Given announcements regarding the industrial production figures for April and inflation numbers for May and the outlook for interest rates, what the road ahead for the bond market and the rupee?
Bond market will continue to seek RBI support for the government’s borrowing programme through open market purchase of bonds. Given the tight liquidity conditions, constant supply of government bonds and sticky inflation, there is an upside risk to yields until the next monetary policy at least. The 10-year yield is likely to hover in the range of 8.15 – 8.50 per cent.
Rupee can remain under pressure as the pace of capital inflows remains sluggish in an environment characterized by severe global investor risk aversion. However, further softening of oil prices and reduction in gold imports will help contain the pressure on the INR.
Overall, as long as the investor risk appetite remains weak, the rupee will remain prone to bouts of weakness. Any efforts from the government to curb the fiscal deficit or to improve the flow of foreign capital would be positive for the rupee. We expect the rupee-dollar pair to trade in the range of 54.50 – 56.50 for the next quarter.
What is your assessment of how things have panned out for Greece and the euro-zone? Do you think that the election result is a temporary relief and the EU will eventually split over the next few years?
The situation in the euro-zone will continue to keep the markets in a risk aversion mode considering that there are no quick fixes to the debt crisis. The long-term resolution of the problem requires some form of fiscal union with common Euro-zone bonds and a banking union to back the monetary union and a common currency.
This is akin to a political union and requires consensus among the core Euro-zone economies. In the meantime, reviving growth would be critical in order to contain the sovereign debt spiral and reduce the pressure on bigger countries like Spain and Italy.
The endgame of this crisis is difficult to predict at this stage. The Greek vote will prove to be a temporary relief. Whether immediate or delayed, the markets will eventually return to unresolved issues for the euro-zone.