The Reserve Bank of India (RBI) has developed a strong inflation focus since Raghuram Rajan took charge. It has also apparently set a sequence of time-bound targets which makes central bank action somewhat predictable. The salient details are as follows:
RBI is tracking the Consumer Price Index (CPI) as its primary inflation indicator, rather than the Wholesale Price Index (WPI) followed earlier. Since food has a very high weight in the CPI (almost 50 per cent), food inflation will be a key factor in monetary policy.
It is assumed that the Urjit Patel panel target recommendations have been accepted, since that was the Panel pushing for RBI to track CPI. If that is so, RBI wants the CPI annual rate of change down to below eight per cent in January 2015 and below six per cent by January 2016. (Those estimates are at the upper end of the band that RBI is prepared to tolerate. Ideally, it would prefer a lower CPI rate of change).
The latest inflation numbers show retail inflation for July was running at 7.96 per cent year-on-year compared to July 2013. This is higher than the June rate of change of 7.4 per cent though it is below the RBI's January 2015 target. The underlying reason for the rise is high vegetable prices. Remarkably, international crude oil rates have remained subdued, despite the wars in West Asia. This has had a soothing effect on inflation.
The central bank chose to leave policy rates unchanged in its latest review, probably due to fear that a deficient monsoon would create more upwards pressure on food prices. The chances are good that it will leave rates unchanged through the next few reviews. In fact, there's a chance that rates will be untouched until January 2015. By then, any food inflation caused by a poor monsoon should have run through the system and RBI might contemplate policy rate cuts.
Interestingly, RBI has not raised its estimates for GDP growth in the 2104-15 financial year, though the Governor's latest speech seems to suggest scope for more optimism. RBI is still looking at a median expectation of 5.5 per cent GDP growth, with an upper boundary of six per cent. However, brokerages such as Barclays and StanChart are already talking in terms of six per cent GDP growth being exceeded with a good performance in the first quarter (April-June). Everybody, including RBI, is braced for a stronger second half.
This would imply an acceleration of over one per cent in growth rates, perhaps even 1.5 per cent, since GDP growth in 2013-14 was around 4.7. If the GDP growth rate for the full year climbs above six per cent, India would climb out of the growth recession of the past two financial years. If there are rate cuts going into the last quarter, there would be room for strong improvement in corporate earnings.
The market had already started to discount these optimistic scenarios when the Supreme Court came up with its recent judgement on every coal block allocation since 1993 being illegal. This puts a lot of pressure on the government to find solutions for the mess in coal, since this affects large capacities in the power sector. The SC judgement could force radical solutions.
The next trigger for sentiment could be the official first quarter GDP estimates, which are due late this week. If GDP did grow above 5.75 per cent in Q1, the bulls may start sprinting all over again and the Nifty could be eyeing targets of 8,500.
The author is a technical & equity analyst
