The month of July 2018 has been fairly disconcerting at the macro front. In fact, there have been five key areas of concern for the macros so far in July.
Consumer Price Index (CPI) inflation, which represents retail inflation, went up to 5% in June 2019, something the RBI and its Monetary Policy Committee (MPC) had been cautioning about. This is marginally higher than the level of 4.87% seen in May 2018.
Wholesale Price Index (WPI) inflation, which represents producer inflation, has hit a 5-year-high of 5.77% in June 2018. This level was last seen in late 2013.
Index of Industrial Production (IIP) growth, meanwhile, has weakened to 3.2% in the month of May 2018 (IIP data comes with a 1-month lag), sharply lower than 4.9% reported in the previous month. The sharp fall in IIP was driven by weak manufacturing growth at 2.8%. Manufacturing accounts for over 70% of IIP.
The trade deficit (merchandise trade) has sharply moved up to $16.6bn in the month of June 2018, and the global volatility in crude oil supply has been the key driver behind this. With Brent Crude hovering in the range of $70-80/bbl, the 75% dependence on imported crude is coming to roost.
The rupee has sharply weakened against the dollar and moved closer to the Rs69/$1-mark. For now, the RBI has been defending the 69-mark, but the forex reserves at $406bn are just about sufficient to cover eight-nine months of imports. That will be the RBI’s practical constraint.
What could the rising WPI inflation mean for people and policy?
(Source: RBI and Trading Economics)
The upswing in WPI inflation is a clear signal of pressure on input costs that manufacturers are facing. In most cases, companies have been unable to pass on the costs to the end-user (customer) due to weak demand. Take the case of airlines: A sharp increase in prices of aviation turbine fuel (ATF) in the last one year cannot be passed on to customers due to the competition. This has led to the narrowing of the spread between the revenue per seat kilometer (RASK) and the cost per seat kilometer (CASK).
WPI inflation has to be seen in conjunction with CPI inflation. Since both have been rising, it indicates that the producer inflation is also reflecting on consumer inflation with a lag. With the government announcing liberally higher MSP for Kharif farmers, the cost inflation impact too will be felt after the monsoon.
Why is the widening trade deficit a worry?
(Source: Ministry of Commerce and Trading Economics)
The trade deficit numbers for June 2018 were worrying for three reasons. Firstly, the monthly trade deficit is now averaging over $15bn for the current fiscal and we may close the fiscal 2018-19 with a total trade deficit in excess of $200bn. The full year imports are likely to be in the range of $550-600bn. That is just about eight-nine months of import cover, which is lower than BRICS nations.
Secondly, the sharply widening trade deficit is an indication that exports of goods, despite growing at 28%, and the exports of services have not been able to keep pace. To that extent, the export push via 'Make-in-India' has not delivered the desired results.
Lastly, more than the trade deficit, it is the current account deficit (CAD) that is the worry. CAD has crossed the 2%-mark and is expected to widen to 2.7% by the end of this year. That will not only put further pressure on the rupee but also risk a reversal of the sovereign upgrade that Moody’s had accorded to India last year.
Now, what will be the government's move?
The government currently has a multi-pronged macro problem at hand. Here is what the government could do or perhaps will do in the coming weeks as a policy response:
The RBI and the government are pushing through a resolution to shore up the balance sheets of PSU banks. The latest round is expected to be to the tune of Rs11,000cr. That will not only shore up the capital adequacy but also create resources to lend. That could be positive for IIP growth via commercial credit.
Managing the rupee will be another challenge. The RBI cannot afford to let the rupee weaken too much. India still relies heavily on FDI and FPI investments to bridge the fiscal deficit. A weaker rupee will negatively impact flows. One option would be to push through another tranche of NRI bonds to shore up dollar reserves by $40-50bn. That should take care of the rupee volatility for the time being.
Of course, the RBI always has the choice of increasing repo rates. Higher repo rates will not only curb consumption and reduce inflation, but also absorb the impact on the rupee. If RBI raises the rates, then even the rupee can be defended without dissipating forex reserves.
The June MPC meet saw the first turnaround in the RBI’s dovish stance when rates were hiked by 25 basis points. The current situation could leave the door open for more rate hikes this year.