India: Keeping Inflation In Control Is Key

| About: WisdomTree India (EPI)

Summary

Macro trends like to see greater influence from developing markets.

Monetary policy being shaped by consumer inflation trends.

Reduced rate outlook supports the argument for higher valuations in INDA.

Under the Chairmanship of Urjit Patel, the Monetary Policy Committee (NYSE:MPC) of the Reserve Bank of India (RBI) recently announced a rate cut which took most analysts by surprise. This increased volatility in regional assets and this has further given space to another potential round of rate cuts in the December and this has view has been largely confirmed in the expectations of many trade analysts.

Examples of this can be seen in the opinions of HSBC, which has suggested that the RBI can withstand potential inflation criticism if they opt for a rate cut in their December review. However, it will be difficult to speculate much beyond, and this is more rate cuts cannot necessarily be expected after December. This could be attributed to the factors which have contributed to inflation recently, and key examples here include factors like house rental allowances and the implementation of the Goods and Services Tax bill (NYSEMKT:GST).

Chart View: India Inflation Rate

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Forex Chart Source: Modern Forex Trading

In August, the consumer price index rose by 5.05 percent year-on-year, which is evidence that the numbers for September 2016 were a positively as they rose only by 4.31 percent. Going forward, the future of rate cuts is dependent on the inflation targets the RBI has set for itself. With the RBI striving hard to bring down inflation during the tenure of Raghuram Rajan, it has been able to manage in driving consumer prices down to 5 percent (though the official target set is four percent by March 2018). So, at this stage we can see the numbers suggest this would certainly not be an easy task.

According to Christopher Wood, the Managing Director of CLSA, this latest rate cut has given the RBI Governor Patel more flexibility in meeting the inflation target of 4 percent. The RBI believes that food inflation momentum has moderated, and the bank has lowered the repurchase rate to 6.25 percent in order to be able to infuse liquidity into the banking system.

Chart View: India Interest Rates

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Forex Chart Source: Modern Forex Trading

All these factors are indicating that we will see an easy monetary policy given the fact that the credit growth rate is more or less in line with the nominal GDP growth rate. The liquidity crisis of banks is another situation which is a concern for the RBI. During mid-July, the banking sector went into a condition of surplus liquidity due to aggressive bond purchases that were done previously by the RBI. This action from the RBI was in response to the liquidity shortage in Feb-March.

Liquidity Factors

If and when the liquidity dries up, the RBI intervenes and buys bonds from the banks. This liquidity rendered into the system by the RBI could have a limited inflationary impact if certain rules were respected. But the lending exercises of the banks has been slowing and this has given room to the RBI to start purchasing bonds because not much money is being created. This has led reductions in the multiplier in somewhat unexpected ways.

These bond purchases by the RBI are called Open Market Operations (OMO) or secondary market bond purchases, and they can result in inflation when the banks are initiating more OMOs than is required. The central bank is just catering to the economic requirements -- and hence these factors cannot be attributed to producing inflation.

Recent economic changes not only in the US but in India as well have had an influence on the Indian Rupee. The moves seen in the Indian government to derecognize notes of higher denominations actually led to the tumbling of equity indices in some cases -- so the RBI needs to tread lightly in its next moves. The SENSEX has risen above 27600 already this month, so at least markets have been responding favorably.

Chart View: India SENSEX Stock Index

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Forex Chart Source: Modern Forex Trading

Stock charts for the region have been volatile throughout, but moves have been positively with the Rupee strengthening after with the election of Donald Trump as the President of United States. The impact on the USDINR has been somewhat subdued, however, as markets are still bracing for the broader effects.

Chart View: Indian Rupee

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Forex Chart Source: Modern Forex Trading

Analysts are currently eying a change in the approach of US foreign policies. This surprise result has made investors wait to get more clarity on the cabinet and policy priorities. In the condition of such volatilities, the market provides opportunities to buy into targeted stocks while investment analysts still advise to wait till clouds clear. This means buying USDIDR and INDA at current levels.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.