India's Top Forecaster Sees Rajan Holding Rates Until February

  • Central bank to keep benchmark rate unchanged Tuesday: survey
  • Ten-year sovereign bonds set for second straight monthly drop

India’s most-accurate interest rates forecaster predicts central bank Governor Raghuram Rajan will refrain from cutting borrowing costs for at least two quarters as fiscal policy and food inflation threaten to spoil his work.

“The precondition for the next rate cut will be fiscal consolidation, passage of key economic reforms and food inflation behaving well,” said Gaurav Kapur, a senior economist in Mumbai at Royal Bank of Scotland Group Plc, ranked first by Bloomberg for predicting Reserve Bank of India actions over two years. “If there is a general comfort that food will not play a spoilsport over the next six months, then the RBI may have a window of opportunity to reduce rates after the budget,” typically in February, he said.
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A pause until June would be the longest since the nine months ended December 2014, when concern deficient rains would stoke food costs kept Rajan from easing. A Bloomberg survey of economists suggests the central bank will hold its repurchase rate at 6.75 percent on Tuesday, after cutting it 125 basis points this year, including a larger-than-estimated 50 basis points on Sept. 29.

Rajan’s job has been complicated by a proposed increase in salaries of millions of civil servants that could boost consumption and derail plans to curb the deficit. Surging prices of pulses, a staple in Indian diet, threaten to further accelerate consumer-price gains that reached a four-month high of 5 percent in October, matching the RBI target for March 2017.

While Rajan said he is looking to contain the broader effects of a jump in food prices, which make up about half of the CPI basket, some issues are beyond his control. Lentil costs have soared following another year of poor monsoon that parched vast tracts of farm land, prompting Prime Minister Narendra Modi’s administration to plan building up a buffer stock of pulses from imports.

Even as India’s increasing population, growing incomes, rising rural wages and changing dietary habits have swelled demand for pulses, supply has failed to catch up, causing prices to spike, especially in times of a “monsoon shock,” according to Crisil Ltd. Consumer food price-gains accelerated to 5.25 percent in October from a year earlier, led by a 42 percent surge in price of pulses.

“The rise in pulses prices can have a large impact on inflation expectations and can influence wage-price negotiations,” Crisil economists wrote in a report this month. The Indian Institute of Pulses Research forecasts demand at 39 million tons by 2050, which requires output to grow at 2.2 percent annually, compared with the 0.9 percent seen in the last decade, according to the report.

Wage Increases

A panel appointed by India’s finance ministry this month recommended a 23.55 percent increase in the salaries and allowances of federal government employees. The recommendations, if accepted, will cost the administration 1.02 trillion rupees ($15.3 billion) in the year starting April 1 and also threaten to fuel inflation.

A report Monday will probably show Asia’s third-largest economy grew 7.3 percent last quarter, according to a Bloomberg survey.

Fitch Ratings says a higher wage bill, along with increased economic stimulus spending, will make it harder to meet fiscal targets. India aims to narrow the budget gap to 3.9 percent of gross domestic product in the year ending March 2016 and to 3.5 percent the following year.

“There is a risk to CPI” from the pay increases, said Sonal Varma, an economist at Nomura Holdings Inc. in Mumbai. “On the fiscal side, there is a risk in terms of getting to 3.5 percent. Given what the RBI has done, including the 50 basis-point aggressive cut in the last policy, we think the space has been used up completely.”

Bonds, Rupee

Inflation expectations by Indian households have inched up for three quarters in a row, with food playing a key role. The challenge for Rajan is to ensure both prices and consumers’ expectations fall in sync as he seeks to bring inflation down to around 4 percent by March 2018.

Sovereign bonds are feeling the pain. The benchmark 10-year yield has risen 12 basis points in November to 7.76 percent, and is on course for its biggest two-month advance since September 2013. Bonds have fallen this month also as foreign holdings of rupee-denominated debt dropped by 38.5 billion rupees amid speculation the Federal Reserve will raise U.S. interest rates before year-end. The rupee has weakened 2.3 percent in Asia’s worst performance.

Investor sentiment was soured also by this month’s defeat for Modi’s party in elections in the state of Bihar, which makes it harder for his government to pass laws in the upper house of parliament. That, along with reduced scope for monetary easing, could hurt prospects for faster economic growth.

“Whichever way we look at it at this point in time, I do not see the potential of a rate cut,” said Kunal Kundu, an economist with Societe Generale SA in Bengaluru. “The ball has to be mostly in the government’s court. Reforms have to take place.”

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