Following three 25 bp rate cuts earlier this year, the easing cycle of the Reserve Bank of India (RBI) may not be over just yet, given still-high real interest rates and a slow recovery in domestic demand. So far, retail inflation has remained below the bank’s target, while deflation continues to affect the wholesale price index. However, as favourable base effects taper off, global oil and commodity prices begin to stabilize, and domestic demand improves, inflation is seen accelerating in the second half of 2015. The rising likelihood of an unfavourable monsoon season is adding another risk, which in the end may play a major role in the RBI’s upcoming monetary policy decisions, given its effect on food prices – and their subsequent impact on India’s rate of inflation.
India's CPI inflation ended its easing trend in May, accelerating 5% y-o-y from April's 4.9%. This modest uptick in the headline figure was largely on account of firming crude oil prices, which contributed to building price pressures in fuel and lighting, as well as transport and communication components. Although some monthly variations are still possible, the general inflation trend is now on the upside. The ongoing recovery in oil prices are seen pushing consumer price inflation up to 5% by the end of 2015. This is combined with a likelihood of rising food prices, given the Indian Meteorological Department’s projections that the summer monsoon rains will be below their historic average.
During its recent policy meeting earlier in June, the RBI cut the leading repo rate by 25 bp, taking advantage of favourable inflation trends so far. The pace of deflation in the y-o-y wholesale price index (WPI) slowed to -2.4% y-o-y in May from a decline of -2.7% in April, which was broadly in line with expectations. Smaller y-o-y declines in the WPI in May compared to previous months were attributed to firming crude oil prices, which affected the "fuel and power" and "transport" components of the WPI. Nonetheless, the WPI continued to fall for the seventh straight month, the longest stretch of WPI deflation in the series' publication. Following three policy interest rate cuts this year (the latest one in June), the scope for further policy easing may narrow, with any additional easing in 2015 highly conditional on the outcome of the monsoon season.
In terms of current account deficit (CAD), India’s CAD decreased sharply to in 1Q15, falling to 0.2% of GDP from 1.7% in 4Q14. As a consequence, the CAD for the full fiscal year 2015 narrowed to 1.3% of GDP, the lowest in seven years, from 1.7% of GDP in FY14. It seems falling oil prices accounted for the bulk of the decline in the CAD, which narrowed by about $6.9 billion between 4Q14 and 1Q15. However, 80% of the sharp decrease is related to lower net oil imports. Lower oil prices dragged down commodity exports, but even manufacturing exports contracted in 1Q15 (versus 1Q14) and grew by only 5.4% in nominal terms for the full fiscal year, implying even weaker volume growth. India’s May deficit narrowed to $10.4 billion after reaching $11 billion in April. Gold imports narrowed but the compression, rather than being driven by weak exports, was largely a monthly decline in non-oil and non-gold imports, which took some of the sheen off of other high frequency data pointing to firming growth in the 2Q.
On a y-o-y basis, exports nose-dived a remarkable 20.2%. But this fall was largely due to lower commodity exports, which plunged 45.4% y-o-y in May on the back of lower commodity prices.
The growth in April’s Industrial Production (IP) was a remarkable 4.1% y-o-y on the back of surging capital goods output. Given the high volatility of monthly IP data, it is normally risky to over-interpret any one month’s number, especially if driven by volatile capital goods production. But this time may be different. For starters, March’s IP growth was revised up from 2.1% y-o-y to 2.5%. But more importantly, the upside IP surprises have come on the heels of strong indirect tax collection in April and May, as well as solid commercial vehicle sales in May, suggesting growth may finally be gaining some impetus.
Following the pick-up in the growth rates for output and new orders seen in May, June’s PMI data pointed to a slowdown in India’s economic upturn. New business expanded at a noticeably weaker pace, in part reflecting a loss of momentum in export business. Moreover, manufacturers remained cautious and employment numbers were unchanged once again. Recording above the 50 no-change mark for the twentieth successive month, the PMI pointed to continued improvements in operating conditions. The index fell from 52.6 in May to 51.3 in June. New export orders received by Indian manufacturers rose for the twenty-first month in a row in June.
The Modi government has set an April 2016 deadline for rolling out a dual goods and services tax that is intended to replace the country's plethora of indirect taxes. It is expected to have positive effects on GDP growth in 2016 because it is seen as contributing to a boost in productivity, the creation of a unified market and cutting down on the large number of taxes imposed by the central government. It is also seen as lowering the incentive to evade taxes and widening the tax base.
The growth forecast for 2015 remains unchanged at 7.5% and the expectation for 2016 is 7.7%.