Managing Indian Inflation a Herculean Task

The Reserve Bank of India (“RBI”) issued its Sixth Bi-Monthly Monetary Policy Statement on February 07, 2018 (“MPS”). The Monetary Policy Committee (“MPC”) decided to “keep the policy repo rate under the liquidity adjustment facility (“LAF”) unchanged at 6.0%”. RBI believes that its decision is consistent with the objective of achieving the medium-term target for consumer price inflation (“CPI”) of 4% within a band of +/- 2 % while supporting growth. In other words, RBI’s monetary policy stance is to box-in inflation into a range of 2%-6%, with a midpoint of 4%. To put it in context, the Federal Reserve prescribes a target of 2%, so does the European Central Bank (“ECB”) while the Bank of Canada is working towards a midpoint of 2% with a range of 1%-3%.
RBI’s broader and higher inflation targeting is an acknowledgement of the difficulty inherent in ensuring price stability in a structurally challenged economy undergoing lop-sided development. Whimsical economic policies undermining the well-being of citizens, a teetering public banking system surviving on hope and government bail-outs ever so often, and a capital market buffeted by inflows of foreign capital looking to make a quick buck, are all significant demands on RBI.

Cautious Monetary Policy Statement

Nevertheless, the MPS provides valuable insight into underlying trends in the Indian economy. Depending on the observer, these can all be explained as temporary and related to a specific factor and hence fixable, or cumulatively they paint a picture of rising inflation and prospectively higher rates, or a weaker currency.

1. As per advanced estimated of the Central Statistical Office (“CSO”) gross value-added (“GVA”) growth declined 14% y-o-y to 6.1% in FY18 from 7.1% in the prior year.

2. Retail inflation as measured by CPI increased for the 6″ consecutive month and more importantly excluding food and fuel, grew at a faster rate in November and December than previous months. Thus volatile and non-volatile categories are trending upwards in sync.

3. Household inflation expectations are high, and firms are reporting input price pressures.

4. RBI’s inflation outlook suggests inflation is edging up towards the outer range of its policy for both Q4-F18 and the first half of F19. RBI anticipates CPI inflation of 5.1%-5.6% for the first half of F19, with some additional breathing room in the 24 half, subject to half a dozen caveats including usual culprits such as normal monsoons and pliant commodity prices.

India’s supply-side bottlenecks and institutional inertia are making the job of RBI difficult, although RBI believes that the recapitalisation of public-sector banks (“PSB”) should improve credit flows. RBI is optimistic that the recent dip in GVA will reverse itself meaningfully in 2018-19. RBI also believes that current initiatives in the budget will support rural demand and _ provide additional impetus to aggregate demand and economic activity. If accurate, in our view that can only harden the inflation outlook and not dampen it.

Institutions Need Integrity – Which NPA Number to Trust?

ANTYA believes RBI needs to telegraph to the Government of India, and capital market participants that accommodative monetary policy by itself cannot push Indian economic growth higher. RBI cannot and should not bear the burden of weak corporate and political governance embedded in institutional laxity and couched in rhetorical slogans.

Although RBI has undertaken a commendable and significant effort to clean up the PSBs, we are once again alarmed by ad-hoc exclusions from NPAs of certain types of loans and advances. For instance, we quote the following gem courtesy a Bloomberg Quint story written by the Group Chief Economic advisor, Soumya Kanti Ghosh, of the State Bank of India; “RBI has allowed banks and non-bank lenders 180 days time to not downgrade the asset classification for non-repayment of dues by GST-registered MSMEs. This will definitely help cash-strapped MSMEs and banks…”

MSME refers to micro, small and medium enterprises. While there is no doubt that non-payment of principal and interest obligation helps cash flows, it is astounding to us that the so-called MSME enterprises are so devoid of liquidity that they are unable to fulfil their interest and debt repayment obligations collectively across the entire banking system. More importantly, the problem is big enough for RBI to have stepped in with a directive allowing the exclusion of MSMEs non-performance from NPA calculation. That prevents a build-up of NPAs in the banking system, making underlying financials look better than they are; but what about BIS then?

Does this imply that recently reported NPAs by financial sector companies in India would be worse in absence of this specific RBI directive? In our view, that suggests NPAs and stress within the financial system remains high and could disappoint everyone in the second half of 2018 once again, as MSMEs and banks run out of GST based RBI lifeline. For those investors buying Indian financials stocks and Indian equities, it is imperative to be aware of these unique issues, which make bench-marking valuations to global or even domestic peers irrelevant from an investing standpoint.

Despite multiple initiatives to clean-up the Indian banking system, RBI continues to extinguish fires as they arise, just that, in this specific instance it is merely postponing the inevitable and allowing the financial system to build some capital, before stepping up its regulatory oversight once again.

Indian Yields Headed Higher

Jean Claude Trichet, the former President of the ECB, said today (February07.2018) on Bloomberg that, “It is important for the central bank to be credible in the eyes of the economic participants”. He followed it up by saying that, “You do not please always the executive branches when you are the central bank”. The failure of INR demonetisation to shore up capital at the public-sector banks and provide the Government of India with a significant dividend has already cast doubts on RBI’s independence and _ objectivity. RBI’s continued accommodative stance towards defaulters emboldens the Indian banking system to play truant with regulators and investors. Moreover, it reinforces a culture of complacency in a managerial cadre that is looking for the next excuse
and leeway to cover its poor decision making.

Notwithstanding, Mr Ghosh’ belief that “… the 10-year yield in India is at elevated levels and not in sync with macro fundamentals”, we believe that the yield will be higher within six months.

Dr Patra who voted for an increase of 25 basis points at the MPC would side with us.