Category Risk Management

India: Seasonal hike in CPI puts pressure on RBI

30 August 2017 Coface

After touting better food management as a reason for low inflation figures in the past months, a pickup in vegetable prices, led by tomatoes, has driven India’s consumer price inflation (CPI) up again.

CPI increased to 2.4% YoY in July, from 1.46% YoY in June, as heavy rains reduced the supply of key perishables. Food accounts for 46% of India’s basket, meaning that seasonal adjustments can have a huge impact on inflation. For instance, excluding tomato prices, CPI came in flat at 2% in July, according to figures by Bloomberg.

Notwithstanding this seasonal uptick in inflation, the Reserve Bank of India (RBI) actually trimmed the policy repo rate by 25 bps to 6.00% on August 2, citing low inflation and a widening output gap as the main reasons. This could mean two things: 1) RBI’s forecasts underestimated the inflation outlook; or 2) the bank is worried about economic momentum. Option two offers a more likely assessment. RBI is more concerned about low investment levels, which have been affected by high real borrowing costs.

Governor Urjit Patel voted to cut rates following months of pressure from Prime Minister Narendra Modi’s administration. The move was justified, as the main risk factors for keeping rates on hold – mounting price pressures and a narrowing output gap – had failed to materialise.

More importantly, real borrowing costs climbed to new highs despite policy rates being at the lowest level since 2010. This is a reflection of poor monetary policy, which remains a key concern for RBI. Festering loans amounting to as much as US$180-billion are pushing companies to reduce debt, keeping investments low and limiting job creation. Likewise, mounting pressures are preventing banks from lending, exerting upside pressure on rates and aggravating existing bad debt concerns.

India’s non-performing loan (NPL) ratio currently stands at 9.2%. This has already started to lead to pressures. Defaults on bonds and syndicated loans of Indian companies reached US$2 billion in 2017 YTD, compared with US$494-million in 2016, according to figures by Bloomberg.

Not surprisingly, deputy governor Viral Acharya stated that “stressed bank balance sheets have resulted in poor monetary policy transmission” and “efforts on stressed asset resolution are firmly underway” in the bank’s latest Meeting Minutes. In the absence of depreciatory pressures, RBI will find it harder to justify another rate
cut in October, which means more will have to be done to ramp up stressed asset resolution measures.

That said, consumer price inflation has been on a downtrend since mid-2016. Structural reforms implemented by Modi have resulted in better food management practices. Energy prices, another volatile component, have benefited from falling crude, India’s largest import. Moreover, domestic demand remains weak, with industrial production and the eight infrastructure industries index falling to multi-year lows of -0.1% YoY and 0.4% respectively in June.

The rupee strengthened to USD/INR 64.18 in August, making imports cheaper. Rupee strengthening can be traced back a weaker dollar as well as Bharatiya Janata Party’s electoral wins in Uttar Pradesh and Uttarakhand – positioning Modi for a second term in 2019.


1) Inflation: Coface expects CPI figures to remain high in August to September, before falling again in Q4. This means inflation will converge up towards its 12-month moving average (Chart 1) by end-2017. This is in line with RBI’s 4% target, but it does not justify further cuts. Risks to our outlook include: a good harvest flooding the market sooner than expected, significantly weaker commodity prices and steep rupee appreciation.

2) Monetary policy: With less room to ease and mounting pressures, the RBI will have to focus on ensuring healthy bank and corporate balance sheets, developing the domestic bond market and promoting market-based benchmarking of bank lending rates. For example, an amendment of the Banking Regulation Act in May will allow RBI to spur write downs.

Lenders can also convert bad debt into equity under the strategic debt restructuring scheme. But banks remain undercapitalised, meaning that the RBI will have to inject more cash into the banking system or allow for consolidation in the sector. Stressed asset resolution measures take time.

Borrowing costs are expected to remain high, which will continue to hamper investments and lead to a widening output gap. Businesses may also find it harder to refinance their existing debt commitments, exacerbating the already high rates of corporate bond and loan defaults.

3) Exchange rate: The rupee is expected to remain relatively stable in 2017. However, like other emerging currencies, it is vulnerable to a rise in global risk aversion and the evolution of monetary policy in the United States. Coface sees some appreciatory pressures stemming from limited policy space in Mumbai, a more dovish Fed and a continuum of weaker oil prices.

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