Economic data: IIP, CPI, CAD
US Fed policy
How are the Indian and global economic environments affecting the financial markets?
A slew of economic data has affected the markets this week.
- Though the index of industrial production (IIP) has shown growth in April 2018, the reaction of the markets to it has only been moderately positive because year-on-year IIP has gone up only by 4.9%, moderately, below expectations. Year-on-year CPI headline inflation accelerated to 4.87% in May 2018 but is still within the forecast of the RBI for 2018-2019. As expected, the current account deficit (CAD) widened to 1.9% of GDP in the last quarter of 2017-18, an inflationary development that is largely attributable to the higher price of oil imports. The RBI is facing a situation of rising inflation and higher growth and could, therefore, raise the repo rate by another 25 basis points in its August 2018 meeting if inflation data shows continued increase by July 2018. It should be noted here that the output gap for the Indian economy – the difference between potential output and actual output – has not yet closed despite sound growth numbers while core CPI (inflation excluding fuel and food) is above the upper limit of RBI’s comfort zone of 2% to 6%, though the RBI typically prefers to use headline CPI (inflation including fuel and food) to make policy. Ideally, the RBI’s monetary policy expectation is that, in the medium term (1 to 2 years), core and headline inflation should converge to the RBI target of 4%. If inflation continues to rise and exceeds 5%, the RBI will need to change its stance to ‘hawkish (tighten)’ from ‘neutral’ in the second half of 2018 which may not be good for growth and the financial markets.
- Rising rates in the US due to the Fed policy of gradually removing monetary accommodation through 2019 but on a data dependent basis is proving to be a difficult development for emerging markets such as India. Interest rates are rising in the emerging markets in part because of the repatriation of foreign institutional investor (FII) funds back to the US due to rising domestic US rates. This will pressure the Indian equity and bond markets.
What to expect from the markets next week?
The equity and commodity (including oil) markets are expected to trade in a range-bound manner. There are no domestic or global triggers at the moment to push the markerts down. On the downside: (1) intensifying trade disagreements between US and Europe, Canda and Mexico and between US and China could cause some perturbation in the global markets which may not strike the Indian markets with the same intensity because India is not a stakeholder to the same extent as the other countries are in trade disputes with the US; and (2) oil price has stabilized in the range of USD 65-80/barrel but the price will continue to adversely impact the Indian trade deficit. On the upside: (1) capital investment by companies in India is expected to continue to increase though spending on consumer durables may be moderate, keeping the IIP moderate; and (2) corporations will begin releasing quarterly earnings reports again starting in the first week of July and there are no indications of any undue stress on earnings. Therefore, on balance, the markets will be less volatile, stable and positive next week. To watch, however, would be the market reaction in India to global cues about the monetary policy stance of the European Central Bank (ECB) and China’s weak economic data.