Exports in February 2017 grew at the fastest pace since September 2016 signalling a recovery in world trade brought about by improving growth in US and Eurozone. Read our Global Economic Data Analysis for March 2017. Exports grew for the sixth consecutive month after a prolonged period of negative growth.
Inflation indicators too have shown a rise with the WPI-CPI spread rising and core inflation staying sticky at 5% levels indicating that demand has not fallen in the economy despite demonetization pressures. RBI cited core inflation as one of the reasons for changing its stance from accommodative to neutral.
Bank credit growth at below 5% levels is still a big concern for the economy but the issue requires a resolution on bank’s bad debts. Banks, especially public sector banks, are reeling under bad debts that are in double digits as a percentage of advances. RBI is mooting the idea of a Bad Bank to absorb the bad debts in the banking system but that will face resistance at the political level.
Going into its April 2017 policy meet, RBI will have three major factors to consider while setting policy rates. The first is the fact that the Fed hiked rates in March and has guided for more rate hikes this year. However Fed has not shown an hawkish stance despite strong labour markets in the US and that has calmed global financial markets. RBI did expect a Fed rate hike and has priced in three to four rate hikes in its current neutral policy stance.
RBI’s second factor to consider is the domestic economy that is showing incipient signs of growth. The key question is will inflation expectations rise on higher economic growth? RBI will prefer to wait and watch on this factor, look at monsoon forecasts and pricing ability of corporates before giving guidance on inflation. RBI should maintain CPI inflation expectations at around 4.5% to 5% levels for fiscal 2017-18.
The third factor for RBI is the strong showing in state elections by the Modi government. The government has shown a willingness for fiscal consolidation and has not gone populist for growth, in fact demonetization was definitely a growth negative measure. Fiscal consolidation by itself can lower inflation expectations as expenditure will largely be on improving the supply dynamics in the economy. Introduction of GST in July too will see longer term revenue benefits to the government.
RBI should largely stay neutral in its April policy.