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Central bank advisories are never too clear on intent but Tuesday’s policy statement was more clear than most. First, the Reserve Bank of India (RBI) is seriously worried about the twin possibilities of rural distress and food inflation. Both are tied to poor monsoon expectations. If the monsoon is deficient, it will be the second time in a row.
Unseasonal rain has hit agriculture in Q1 of 2015-16 and a poor monsoon could easily cause a drop in supply, which leads to a big spike in food inflation. Given the high weight of food in the Consumer Price Index (CPI), it could move the latter to a point where RBI’s targeted rate of change of six per cent or lower by January 2016 is in question.
The food basket has a weight of over 45 per cent in the CPI. So a change of a little over 200 basis points in the food price index would translate into one per cent rise in CPI. This is one reason why RBI expects inflation to rise after August (there could also be a low-base effect, since inflation came down from September 2014).
Crude prices might also have bottomed out and may be headed up. A sudden surge cannot be ruled out, given turmoil in West Asia, North Africa, and Nigeria. Higher crude would also spark inflation.
RBI has taken note of the pared growth estimates for 2014-15 by about 0.3 per cent by the Central Statistical Organisation. It has also pared its 2015-16 estimates. Along with the poor performance in core industries, moderate gross domestic product growth is a good argument in favour of cutting rates.
The repo rate cut of 25 basis points was “front-loaded”. This is being interpreted to mean RBI will not cut again for a while. The central bank will wait on several things. One is actual progress of the monsoon.
Another is a hike in dollar policy rates by the US Federal Reserve. Once there is a hike, the Indian central bank and every other will have to make a call on where it wants their currency to be placed vis-a-vis other currencies in the forex market. What happens to the rupee as the spread reduces between US and Indian treasury yields of comparable tenure?
RBI also clearly wants the government to come through with various policy and administrative measures to relieve stress on the banking sector. It wants capital subscription to public sector banks (some of which might be close to having their equity base wiped out by non-performing loans). It is also hoping for good food management — a point mentioned several times in the statement. RBI is also hoping for an unclogging of stalled infrastructure projects.
The market action after Tuesday’s rate cut is interesting. There was a lot of short-term money betting on a bigger cut. Bond yields rose slightly, indicating a sell-off in debt markets, and of course equities dropped sharply. The rupee also fell, which could indicate foreign money pulling out.
In itself, that sort of bearish session can trigger sustained selling. The Bank Nifty and the Nifty itself have both dropped near their respective 200-Day Moving Averages (200-DMA) but they have not decisively broken it yet. If support breaks at those zones, corrections of three-five per cent would be likely within the next five sessions. That is a short-term trading perspective. In the long-term, a sustained period of trading below the 200-DMA could lead to more bearish conditions.
