RBI Moves Closer to a 25 bp Hike

new India

The Reserve Bank of India delivered a hawkish hold.  It was critical of fiscal policy, and we think risks of tightening are higher than the market expects. 


Eight states will hold elections this year.  In H1, the states of Nagaland, Tripura, Meghalaya and Karnataka will vote.  In H2, the states of Chhattisgarh, Madhya Pradesh, Rajasthan, and Mizoram will vote.  The BJP and its allies currently control 19 out of the 29 state governments, and these state elections will be a good barometer of the national mood.

National elections will be held mid-2019.  In the 2014 elections, the BJP won an outright majority with 282 out of the 545 seats in parliament.  The BJP still chose to rule in coalition as the National Democratic Alliance (NDA), giving it a total of 336 seats.  This was the biggest majority since the 1984 elections.  The opposition remains weak, with the former ruling Congress Party winning only 44 seats in 2014.

Support for the BJP may have peaked, however.  Polls by the paper India Today have shown declining support for the NDA since the beginning of 2017, when the NDA was tapped to win 360 seats.  That number has fallen to 309 at the beginning of 2018, though it’s still a majority.

Prime Minister Modi delivered some early reforms, but his track record has become spotty.  The demonetization in November 2016 was controversial, and ended up hurting many in the rural areas.  The introduction of the GST last year has also proven to be disruptive for consumers and businesses.  Hence, Modi is boosting spending and programs in the rural areas to win back support.

India scores poorly in the World Bank’s Ease of Doing Business rankings (100 out of 190).  The best components are protecting minority investors and getting electricity and credit, while the worst are dealing with construction permits and enforcing contracts.  India does slightly better in Transparency International’s Corruption Perceptions Index (79 out of 176 and tied with Belarus, China, and Brazil).


The economy is recovering but risks remain.  Demonetization and introduction of the GST last year were headwinds on the economy.  GDP growth is forecast by the IMF to accelerate modestly to 7.5% in FY2018/19 from an estimated 7.1% in FY2017/18, before picking up to 7.7% in FY2019/20.  GDP rose 6.3% y/y in Q3, up from the trough of 5.7% y/y in Q2.  Q4 growth is expected at 7.0% y/y but we believe recent readings highlight downside risks to the growth forecasts.

Price pressures are rising.  This is due in part to the impact of higher taxes.  CPI rose 5.2% y/y in December, which is in the upper end of the 2-6% target range.  January CPI data will be reported on Monday, and we see upside risks.  WPI inflation has also been accelerating, which suggest consumer price pressures will rise further in the coming months.

Reserve Bank of India just delivered a hawkish hold.  The vote to hold was 5-1, with the lone dissenter seeking a hike.  The RBI warned that “Apart from the direct impact on inflation, fiscal slippage has broader macro-financial implications, notably on economy-wide costs of borrowing which have already started to rise. This may feed into inflation.”  As such, we think a rate hike is becoming more likely at the next policy meeting April 5.

Fiscal policy is deteriorating.  Whilst the introduction of the Goods and Services Tax (GST) was positive, its impact will be muted by the expansionary fiscal stance planned for FY2018/19.  The government now targets a budget deficit equal to -3.3% of GDP for FY2018/19 starting April 1.  This is up from its previous target of -3%.  The deficit was estimated at -3.5% of GDP for FY2017/18 ending March 31, up from -3.2% previously forecast.

The external accounts should worsen modestly.  Over the past couple of years, low commodity prices helped reduce imports.  Those trends have now reversed.  The current account deficit was an estimated -1.4% of GDP in FY2017/18, and is expected by the IMF to widen to -1.8% in FY2018/19.  However, the rapidly widening trade gap suggests upside risks to the external accounts.

Foreign reserves have risen to record highs.  At $418 bln in January, they cover nearly 9 months of import and are almost twice as large as the stock of short-term external debt.  Thus, external vulnerabilities remain fairly low.


The rupee has done OK after performing with the rest of EM in 2017.  In 2017, INR rose 7% vs. USD and was in the middle of the EM pack.  The best performers were KRW (+13%) and MYR (+11%), while the worst were ARS (-14.5%) and TRY (-7%).  So far in 2018, INR is -1% YTD and is still in the middle of the EM pack.  The best performers YTD are MXN (+4%) and COP (+4%) while the worst are ARS (-6.5%) and PHP (-3%).  Our EM FX model shows the rupee to have STRONG fundamentals, so it should start to outperform more.

Indian equities continue to modestly underperform in EM.  In 2017, MSCI India rose 29% vs. 34% for MSCI EM.  So far this year, MSCI India is flat YTD and compares to 1% YTD for MSCI EM.  This underperformance should grow, as our EM Equity model has India at an VERY UNDERWEIGHT position.

Indian bonds have performed OK recently.  The yield on 10-year local currency government bonds is about +15 bp YTD, also in the middle of the EM pack.  The best performers are Peru (-42 bp) and Brazil (-45 bp), while the worst are Pakistan (+59 bp) and Hungary (+58 bp).  With inflation likely to continue rising and the central bank likely to tighten this year, we think Indian bonds will start underperforming more.

Our own sovereign ratings model showed India’s implied rating falling a notch to BBB/Baa2/BBB, giving back last quarter’s improvement.  Several years ago, India was facing downgrade risks to its BBB-/Baa2/BBB- ratings.  While we are still seeing some modest upgrade potential, it seems to be ebbing.