 "Keep an eye on the Bank Nifty")
The Reserve Bank of India has held rates in what is seen as a gamble. The central bank hopes inflation will decrease quickly. The calculation is based on its projection of food price direction and it appears to believe vegetable prices will come down in the next few weeks. There is usually such a winter seasonal effect.
The central bank should have access to December food price data while we are still dealing with official November inflation index data. A comparison of November and (current) December food prices should help RBI decode the sense of direction. So, perhaps it is less of a gamble than it seems at first sight.
Food inflation has been one of the most intractable issues for policy makers over three years. Efforts to control food prices purely by monetary measures doesn't work. Several explanations have been offered for the uptrend. One is that this is an effect arising from higher rural incomes and poverty reduction schemes. People at the bottom of the income pyramid can afford to buy more food and agricultural input costs have risen. So, the rise in food prices is "natural".
But the larger issues lie with the procurement system, which cannot deliver food supply where and when it's needed. That system varies in detail from state to state. But it is clearly broken almost everywhere. It is also impossible to fix. Politicians across party lines are large-scale beneficiaries of the current system and they will fight against reforms.
RBI can do nothing about this. Rajan has decided to cross his fingers and hope it will correct to some extent. If food prices don't correct, however, he has few choices. RBI will have to hike rates, and it may do so "off-policy" dates as it has warned, if necessary.
There is a chance that such a corrective step will be required when the next set of inflation data comes in, in mid-January. By then, there will also be some clarity on how foreign institutional investors (FII) are adjusting to the new, slightly reduced QE3 (the third round of Fed's bond-purchase programme) levels. If there are signs of FII money pulling out of emerging markets, RBI could be forced to raise policy rates anyway, to protect the rupee from a sharp fall.
This may happen in January. But RBI's pause in interest rate action is not likely to last long. There is a pretty good chance that it will need to raise rates before the end of the financial year at the least and some chance that it will have to hike off-policy. That could set up the Bank Nifty nicely for a big crash sometime in the next settlement, or in February.
The other, less likely, possibility is that there will be a rapid fall in inflation. Given that food has a near 50 per cent weight in consumer price indices, a big drop in food prices could trigger that. If so, RBI may follow through with a rate cut. The unexpected nature of such a policy action could set up the Bank Nifty for a big up-move.
Either way, the Bank Nifty is unlikely to stay range-bound at close to its current levels. Since it has the highest weight on the Nifty and is high-beta, it would have a great deal of influence on overall market direction. This is the index to watch - the market will follow where it leads.
The central bank should have access to December food price data while we are still dealing with official November inflation index data. A comparison of November and (current) December food prices should help RBI decode the sense of direction. So, perhaps it is less of a gamble than it seems at first sight.
Food inflation has been one of the most intractable issues for policy makers over three years. Efforts to control food prices purely by monetary measures doesn't work. Several explanations have been offered for the uptrend. One is that this is an effect arising from higher rural incomes and poverty reduction schemes. People at the bottom of the income pyramid can afford to buy more food and agricultural input costs have risen. So, the rise in food prices is "natural".
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There could be some truth to this. But it doesn't explain the massive mark-up between the prices the farmer gets and the prices paid at city wholesale mandis. Nor can it account for the next massive markup that occurs between wholesale and retail prices. Some of those are due to poor logistics - the lack of cold chains leads to high levels of spoilage, etc.
But the larger issues lie with the procurement system, which cannot deliver food supply where and when it's needed. That system varies in detail from state to state. But it is clearly broken almost everywhere. It is also impossible to fix. Politicians across party lines are large-scale beneficiaries of the current system and they will fight against reforms.
RBI can do nothing about this. Rajan has decided to cross his fingers and hope it will correct to some extent. If food prices don't correct, however, he has few choices. RBI will have to hike rates, and it may do so "off-policy" dates as it has warned, if necessary.
There is a chance that such a corrective step will be required when the next set of inflation data comes in, in mid-January. By then, there will also be some clarity on how foreign institutional investors (FII) are adjusting to the new, slightly reduced QE3 (the third round of Fed's bond-purchase programme) levels. If there are signs of FII money pulling out of emerging markets, RBI could be forced to raise policy rates anyway, to protect the rupee from a sharp fall.
This may happen in January. But RBI's pause in interest rate action is not likely to last long. There is a pretty good chance that it will need to raise rates before the end of the financial year at the least and some chance that it will have to hike off-policy. That could set up the Bank Nifty nicely for a big crash sometime in the next settlement, or in February.
The other, less likely, possibility is that there will be a rapid fall in inflation. Given that food has a near 50 per cent weight in consumer price indices, a big drop in food prices could trigger that. If so, RBI may follow through with a rate cut. The unexpected nature of such a policy action could set up the Bank Nifty for a big up-move.
Either way, the Bank Nifty is unlikely to stay range-bound at close to its current levels. Since it has the highest weight on the Nifty and is high-beta, it would have a great deal of influence on overall market direction. This is the index to watch - the market will follow where it leads.