Monsoon, minimum support prices and inflation
Pay adjustment for government employees and inflation
How are the Indian and global economic environments affecting the financial markets?
- Monsoon is proving to be one of the trump cards, as it always is every year, for the Indian economy. As of date, rains have been sub-optimal for the summer – Kharif – crop and if this continues it can have several negative effects: farmer sentiment can alienate the farmers – an important voting bloc – from the government, compounding the sour farmer relations already, affecting the election outcome in 2019 and the politics of policymaking thereafter, in turn affecting the economy and the financial markets; as an immediate effect, sub-optimal farm yields could push up inflation, prompting the RBI to raise interest rates; the need to import food and subsidize farmers cramps the fiscal flexibility the government has by raising the current account deficit (CAD) and the budget deficit; companies and sectors that cater to the farm sector and whose businesses are reliant on farm produce will stand to lose, adversely affecting their market valuations. All of these primary and secondary effects could drag down GDP growth because the agricultural sector provides nearly 60% of employment in India even though it makes up only 15% of the GDP.
- The government is considering another pay increase for central government employees after the recent 7th Pay Commission hike of 2% in Dearness Allowance (DA). Before the election, it wants to modify the index and base year for calculating the DA which is the cost of living adjustment paid to central government employees. The RBI, together with the monsoon, watches for the effect of pay raises to the large number of government employees on the budget deficit and inflation because both of these macro indicators affect the path of interest rates. The allocation of funds by the central government for the pay adjustment could increase the budget deficit and raise inflation which has already crossed the 5% threshold in June (core inflation has already exceeded 6%).
- Oil price, albeit at the lower end of the USD 70-80/barrel range because of the recent easing of supply concerns, will still, despite the Indian equity market rally, continue to put pressure on the CAD, the rupee, and inflation because it is much higher than when the oil price was low in the past several years, pressuring the Indian macro environment together with the probability of a sub-optimal monsoon and government wage increases.
What to expect from the markets next week?
Next week, the behavior of the equity and commodity markets in India and in other major economies will remain consistent with that of this week. They are expected to remain stable and react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may move in a range-bound manner between USD 70-80/barrel, falling due to the trade war and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy, which has performed as expected in the second quarter of 2018, is adjusting to the trade war.