The 3Ms: Monetary policy, Monsoon, and MSPs

India's April inflation readings will not make the Reserve Bank of India's (RBI) job any easier.  Yoy inflation in April per the wholesale price index (WPI) of 4.9% was the lowest reading since November 2009.  Consumer price index (CPI) inflation also declined to 9.4% in April from 10.4% in March, and marked a 14 month low. 

The RBI cuts its monetary policy rate - the repo rate - by 25 bp to 7.25% on 3 May.  Depending upon which inflation measure you use, the real policy rate in India is negative 2.1% (CPI) or positive 2.4% (WPI).  To be fair, the RBI's guidance on future monetary policy action was hawkish given sticky CPI inflation.  For further details on why this disconnect matters, refer India's Inflation Disconnect.

The divergence can partly be explained by the higher weighting of food and food products in the CPI (46%) versus the WPI (24%), as well as CPI food inflation running higher than WPI food inflation (4-6% over the past few months).  Food inflation has been running higher than headline inflation for both the indexes - CPI food inflation was 10.7% in April while WPI food inflation was 6.3%. If we input food WPI into CPI (instead of food CPI), headline CPI in April would have been only 7.2% (a good 2.2% lower).

That said, core inflation per the CPI is also much higher than the WPI.  Core CPI inflation (excluding food and fuel) declined to 8.1% in April from 8.6% in March, while  core WPI inflation (manufactured products excluding food) had a much sharper decline to 2.8% from 3.5%.  

Looking ahead, food inflation trends would be key for both the WPI and the CPI in my view.  Core WPI manufacturing inflation should stay contained at close to 3% as there hasn't been any significant pass through of higher fuel prices so far suggesting muted pricing power. Higher expected diesel and electricity prices should keep fuel & power inflation above 10%.  As such, food prices would be the key variable.

Yoy WPI food inflation (primary food articles and manufactured food products) declined to 6.3% in April from a near term peak of 11.0% in January.  CPI food inflation also declined to 10.7% from 13.2% over the same period.

However, seasonally adjusted numbers for WPI primary food articles suggest inflation of close to 20% (based on a three month moving average) versus the yoy rate of 6.1% (primary food articles drive WPI food inflation because of their higher weighting). As such, even assuming a significant slowdown in seasonally adjusted food inflation trends would imply much higher yoy WPI food inflation post September 2013.

A normal Monsoon (which the Meteorology Department is predicting) would be helpful in keeping a lid on food prices.  Separately, the government also needs to constrain the usual double digit increase in minimum support prices (MSPs) paid to farmers for key crops (may be tough with central government elections in 2014).  With food prices again taking the driver's seat for inflation, monetary policy would be dependent on the monsoon and MSPs.

Creditors’ Rights in Asia Pacific

If return of capital is more important than return on capital, Australia, Hong Kong and Singapore score highly as they have the best creditors’ rights in Asia Pacific.  By contrast, Indonesia and Philippines score poorly on a rough effective creditors’ rights index.

I have calculated a rough effective creditor rights index (0-10) based on the average of the legal rights index (degree to which collateral and bankruptcy laws protect rights of borrowers and lenders) and the resolving insolvency index based on World Bank’s Doing Business data.  Although a country may have strong legal rights, execution (as reflecting by insolvency resolution) may be quite poor effectively diluting the legal rights (India is a good example).

As expected, Australia (10), Hong Kong (10) and Singapore (10) have the best effective creditor rights in the region, and Japan (9), Korea (9) and Malaysia (9) also score highly.  As mentioned above, India’s effective creditor rights (6) are low as weak insolvency resolution (4) dilutes the relatively strong legal rights (8).  China’s effective creditor rights (6) are similar to India as better insolvency resolution (6) offsets relatively weak legal rights (6).  Indonesia (3) and Philippines (3) have the weakest creditor rights in Asia according to this data.

RBI March rate decision - between a rock and a hard place!

RBI's March 19 monetary policy may be closer than the consensus expects ...

Most economists are expecting a 25 basis points cut in the policy repo rate to 7.50% while opinion is divided over a further cut in the cash reserve ratio (CRR).  To review, the RBI reduced the repo rate by 25 basis points to 7.75%, and also cut the CRR by 25 basis points to 4.0% in late January.  Rate cut advocates cite sluggish GDP growth (below 5% in the December quarter) and the decline in core manufacturing WPI. 

... with the continuing disconnect between the wholesale price index (WPI) and the consumer price index (CPI).

India's February CPI (yoy basis) climbed further to 10.9% from 10.8% in January 2013, the highest reading for CPI inflation over its short history.  By comparison, February WPI was 6.8%, the second lowest reading in more than three years (January 2013 at 6.6% was the lowest). The divergence can only partly be explained by the higher weighting of food and food products in the CPI (46%) versus the WPI (24%). Food inflation has been running higher than headline inflation for both the indexes - CPI food inflation was 13.4% in January while WPI food inflation was 10.2%. Indian policy makers and analysts (present company included) have historically focused on the WPI (in contrast to the CPI focus for most other economies) because of its timeliness and breadth; the new comprehensive CPI (rural and urban) with monthly readings was introduced only in January 2011.

Especially as the core inflation measures for the two indexes also diverge significantly.  

The decline in WPI inflation is driven by the moderation in core manufactured products (excluding foods) inflation - core manufactured products inflation declined to 3.8% in February 2013 (the lowest reading in almost three years) from a near-term peak of 8.4% in November 2011. Even seasonally adjusted trends for core manufacturing WPI suggest that inflation pressures are contained.

By comparison, core CPI inflation (excluding food and fuel) remained elevated at 8.4%, having troughed at 8.0% in September 2012. Cutting the repo rate (which is already slightly negative based on the core CPI) given the elevated and sticky CPI inflation would be hard to justify given RBI's stated focus on containing inflation as well as supporting growth.

Above average growth, low inflation - I like the "new normal"!

Economic forecasts generally go with the usual caveats, but the IMF's global economic forecasts suggest a reasonably healthy global economy in the coming five years compared to the economic environment since 1980.

Per its October 2012 World Economic Outlook (updated in Jan 2013), the IMF expects global GDP growth of 3.5% in 2013, just above the average of 3.4% from 1980-2008 (the great recession of 2009 saw a decline of 0.6% in global GDP). The outlook for the following years is stronger with growth of 4% or higher.
Meanwhile, global consumer price inflation is expected to be well contained, remaining below 4%; similar to the levels in 2002 to 2006.  Global consumer price inflation averaged 13% from 1980-2008. 
Expected global growth is slightly below the rates seen in the 2003 to 2007 period, but still seems quite impressive if we look at a longer time period.  Maybe the new normal ain't so bad after all!

Rupee seems fairly valued on a real basis

The Indian Rupee now seems fairly valued on a real effective exchange rate basis.

As such, portfolio flows would be key to the Rupee's direction from current levels with significant downside limited barring significant portfolio outflows.

Note: 

a) A caveat to this analysis is that the BIS uses the wholesale price index (WPI) for India versus consumer price index (CPI) for other countries; as noted earlier by AASSB analysis [refer 14 Feb blog] India's CPI and WPI are quite disconnected at the moment.  As such, India's REER may be understated by using the WPI instead of the CPI.

b) Nominal EERs (NEERs) are calculated as geometric weighted averages of bilateral exchange rates. Real EERs (REERs) are the same weighted averages of bilateral exchange rates adjusted by relative consumer prices. 

Time to look at the yen's real exchange rate

The yen's real effective exchange rate (REER) suggests that the short yen consensus macro trade could be in its last innings.

The yen still seems significantly overvalued versus history on a nominal basis - the monthly average for the yen's nominal effective exchange rate (NEER) in January 2013 was roughly 0.7 standard deviations above its historical average since 1994.

However, as inflation levels in Japan have been much lower than the rest of the world, this has not translated into a loss of competitiveness as measured by the yen's REER (low relative inflation offsets a high nominal exchange rate and vice versa).  The yen's REER in January 2013 was actually 1.4 standard deviations below its historical average since 1994.

The story stays the same even if we look at the yen relative to the Korean won. 

Note: 

a) Nominal EERs (NEERs) are calculated as geometric weighted averages of bilateral exchange rates. Real EERs (REERs) are the same weighted averages of bilateral exchange rates adjusted by relative consumer prices. 

b) Conclusions of analysis may differ based on time periods used; the BIS' broad indices have data from 1994 (used in above analysis).

India's inflation dis-connect

India's January CPI (Consumer Price Index) and WPI (Wholesale Price Index) readings highlight the growing dis-connect between the two inflation measures, and would further complicate monetary policy decision making by the RBI.  This warrants caution on Indian equity markets - expectations of economy boosting lower policy rates (driven by lower inflation) have driven significant foreign investor inflows year to date ($7.8 billion).

Indian policy makers and analysts (present company included) have historically focused on the WPI (in contrast to the CPI focus for most other economies) because of its timeliness and breadth; the new comprehensive CPI (rural and urban) with monthly readings was introduced only in January 2011.

India's January CPI (yoy basis) accelerated to 10.8% from 10.6% in December 2012, and significantly higher than the 7.5% in January 2011.  January 2012 marked the highest reading for CPI inflation over its short history.  By comparison, the January WPI declined to 6.6% (below consensus expectations of 7.0%), from 7.2% a year earlier as well as in December 2012. This was its lowest reading since November 2009.

The divergence is partially explained by a) the higher weighting of food & food products in the CPI (49.7%) versus the WPI (24.3%) as food inflation is higher than headline inflation for both indexes, and b) higher measured food inflation in the CPI versus the WPI (CPI food inflation was 13.2% in January versus only 10.6% for the WPI).

Even the core inflation measures for the two indexes diverge significantly, thought lesser than the headline prints.  The decline in WPI inflation is driven by the moderation in core manufactured products (excluding foods) inflation - core manufactured products inflation declined to 4.1% in January 2013 from a near-term peak of 8.4% in November 2011. Core CPI inflation (excluding food and fuel) remained elevated at 8.4%, having troughed at 8.0% in September 2012.