<b>Devangshu Datta</b>: Cheaper credit unlikely in first half of FY18

The January CPI was 3.17% higher than a year ago, the lowest rate in five years

Indian interest rates dropped in early 2016 and treasury yields fell after demonetisation. Retail inflation has fallen in the last four months. However, the Reserve Bank of India (RBI) has held the policy rate steady in the last two reviews despite the falling Consumer Price Index (CPI). Analysts now expect RBI to maintain status quo until September 2017.

The January CPI was 3.17 per cent higher than a year ago , and that's the lowest rate in at least five years. The December CPI was at 3.4 per cent year on year. But, the CPI construction is such that RBI is nervous about inflation being concealed, or understated.

The food basket has a weight of nearly 50 per cent and food inflation is down to 0.5 per cent, after registering 1.37 per cent increase year on year in December. The rest of the CPI basket (inclusive of fuels) was up 5.1 per cent year on year (Y-o-Y) in January, higher than the 4.9 per cent YoY in December 2016. According to RBI's last policy review (which only had data until December), the non-food basket has seen sticky inflation at 4.9 per cent plus. So, if food inflation accelerates, the CPI could zoom. In fact, food inflation is likely to rise due to seasonal factors, as well as the end of demonetisation.

RBI is also reluctant to cut rates because the differential with dollar rates is narrowing. Dollar yields are rising. Higher US inflation is likely due to a tight American labour market and Trump's protectionism. The Federal Reserve is likely to hike policy rates this year. Europe and the UK are also likely to see higher inflation, (accompanied by growth in the EU).

If the differential with hard currency rates narrows, the currency risk rises for foreign portfolio investors (FPI), who would become reluctant to invest in rupee instruments. FPIs have bought both rupee debt and equity after the RBI held status quo, which is a sign of approval for the policy. The other external risk which the central bank must reckon with is that crude prices have risen and energy prices could stabilise at the current levels, or higher.

Global considerations and attendant currency risks are such that RBI must pay great heed to those factors. Capital from around the world chases the best, risk-adjusted returns. "Risk" in this context includes both geopolitical risks and currency risks.

First World interest rates have been very low since the global financial crisis (GFC) of 2008 and the second GFC of 2011-12. As of now, Japan has a negative policy rate. So, does the European Union and so do several non-EU nations in Europe. There are also quantitative easing programmes across multiple currencies. The US has very low-interest rates. In this period, capital has flowed to Emerging Markets. But, that situation is changing as mentioned.

There are several implications. Until the last RBI review, most analysts had assumed that growth could be driven through the 2017-18 financial year by the disbursal of more credit at lower interest rates. That is probably not going to happen now, at least not in the first half of 2017-18.

Hence, corporates have to cope with credit at around the same rates in the first half of 2017-18. Nor is credit disbursal likely to expand much, until and unless there's a large-scale bank recapitalisation. Domestic debt fund returns will also stabilise at these levels and the windfall returns of November-December 2016 might not be available again. Consumption might expand and that could be a driver for growth. But, higher consumption would have to be a consequence of "remonetisation" rather than being driven by lower rates. 

The author is a technical and equity analyst