Three important macro-economic numbers came in this week and the interim Budget will provide a few more. First, the Index of Industrial Production (IIP) contracted. Second, retail inflation dropped. Third, inflation, as measured by the wholesale price index (WPI), also dropped.
The interim Budget is unlikely to reveal dramatic changes in policy. But it will be accompanied by some growth estimates and some estimates of the fiscal deficit and the Current Account Deficit (CAD). The CAD is likely to have improved a lot. It may be in the range of 2.5-3 per cent of GDP, down from above 5 per cent in 2012-13. Even this is uncomfortably high. But it's not panic stations anymore. The fisc should also be under 5 per cent. If Mr Chidambaram has worked some sleight of hand, he may manage to push the fisc down to 4.5 per cent. Again, high in absolute terms but the trend is improving.
The IIP for December 2013 shrank by 0.3 per cent compared to December 2012. Note that the economy was already in serious trouble in December 2012 so the IIP has dropped compared to a low base. In fact, IIP shrank through all of Q3 (Oct-Dec 2013).
The Consumer Price Index (CPI) for January 2014 rose by 8.8 per cent compared to January 2013. This was a two-year low in the CPI trend. Core CPI (stripped of fuel and food) was at 8.1 per cent, which was marginally higher than in December. The WPI was down to 5.05 per cent in January 2014 - an eight-month low in the year-on-year trend.
The RBI is targeting pulling CPI down to below 8 per cent by January 2015 and the next scheduled policy update is in April. The optimists hope that the falling trend in inflation will induce the central bank to cut rates. The "realists" suggest that the RBI is more likely to hold rates at current levels because core inflation hasn't dropped.
The pessimists would point to the fact that there are two months of data-collection to go before the RBI makes its next call. Inflation usually spikes as summer approaches (because vegetable prices rise in summer) and also when general elections are in the offing because campaign spending pumps cash into the economy.
Major league investment into Indian equity is likely to stay on hold until the elections are done. So the macro-economic numbers will not make an immediate difference to the quantum of cash flowing into Indian stocks. But the RBI's stance would influence investment patterns. Another set of numbers could offer a hint about the RBI's mindset. Bank NPAs are rising and the PSU banks are likely to struggle through the next fiscal. So far, private banks have managed to maintain asset quality. But if growth remains anaemic, private banks will also inevitably be affected.
The current fiscal saw a record number of loan recasts through the Corporate Debt Restructuring (CDR) mechanism. Now many of those CDR approvals are also turning sour and the RBI has tightened the norms for CDR approval. The RBI's key policy focus as articulated recently is to fight inflation. It also has to play a regulatory role to ensure that the banking system remains robustly healthy. An acceleration of growth would actually serve both needs best. If growth remains slow, it's unlikely that the NPA situation would improve a great deal. If growth accelerates, inflation is also likely to be less of a problem. Until growth accelerates however, the RBI has to keep loan approvals tight and rates high to ensure that NPAs don't climb.
Every projection suggests growth will remain slow in 2014-15, with may be, a pick up in the second half of the fiscal. Cutting policy rates would not provide much growth stimulus because of the lack of confidence in government policy and high inflation, which is impeding investment and consumption. Nothing the RBI does will change those attitudes - the political establishment has to take charge.
I think the RBI will hold rates unchanged in April and hope that the next government shows signs of trying to turn things around. It might just raise rates if it thinks inflation will spike going into summer and the general elections. It is not likely to cut rates.
Any central bank has to tackle future inflation expectations as much as it tackles the current inflation rate. Unfortunately, inflation expectations are very high after three years of unrelenting price rise and the expectations won't change in a hurry. By its focus on retail inflation, the RBI has, at the least, targeted the most accurate indicator of expectations. It will need to keep rates high until the expectations change.
