Brief India: Capital Flows Return To Asia and India and more

In this briefing:

1. Capital Flows Return To Asia and India
2. The RBI Duly Caves in to Reality; Tame Inflation Implies a Further Rate Cut in Six Weeks

1. Capital Flows Return To Asia and India

• Latest January ‘flash’ data show cross-border capital returning to Asia
• Asian EM and India favoured
• Reinforces similar evidence in December and helps reverse big outflows a year ago
• Adds support to our view that Asia is leading the Global cycle higher

2. The RBI Duly Caves in to Reality; Tame Inflation Implies a Further Rate Cut in Six Weeks

The RBI (Reserve Bank of India) cut its policy rate by 25bp, with the MPC (monetary policy committee) voting 4-2 in favour of the move. It also altered its monetary stance to “neutral” from “calibrated tightening”. We had said at the time of the RBI’s rate hike last June that it was making a major policy error ( RBI Raises Rates, but Will Likely Look Foolish when Inflation Moderates) because inflation was likely to completely bely the official forecast and move down rather than up. That has duly happened, with CPI inflation at 2.19% YoY in December 2018 (versus the RBI’s June 2018 forecast of “4.7% with risks tilted to the upside”). WPI inflation (not the RBI’s main target) has also eased to 3.8% YoY in December 2018. 

India’s real repo rate of +4.3% was among the highest in the world before this rate cut — and the new +4% real repo rate still remains exceptionally high. Although food prices are likely to decline less rapidly in the current quarter, headline CPI inflation is likely to edge up only slightly to 2.5-3% YoY in January-March 2019. This will allow the RBI to cut the policy rate further to 6% at its next meeting — still leaving the real repo rate above +3%.

The rational decline in nominal policy rates should provide a significant medium-term fillip to growth, allowing real GDP to grow more than 8% YoY in FY2019/20 and more in subsequent years as further structural reforms occur under a rejuvenated Modi government in its second term. After its initial negative reaction, we expect the stock market to also welcome the easier monetary conditions. We recommend staying Overweight the India equity and bond markets, especially after recent sell-offs (i.e., Buy into this weakness).