Inflation data point to more rate cuts

Given a reasonable monsoon, food inflation should remain moderate

The Consumer Price Index and Wholesale Price Index for March were both released last week. Inflation is clearly down.

The WPI is running negative, with a change of minus 2.33 per cent year-on-year (y-o-y), compared to March 2014.

The CPI is running at 5.17 per cent y-o-y.

The WPI time series has five successive months of negative y-o-y change.

The CPI time series, which was at 145.2 in March 2015, has barely changed since August 2014, when it first hit 145.

Core CPI inflation (ex-food and ex-fuel) was at 4.1 per cent y-o-y in March, about the same as in February.

Food and fuel are two perennial areas of concern.

Fuel deflation has been good for India.

The Indian crude oil basket was at $110/barrel in June. It dropped to $55 by February 2015.

The fuel indices in March were down by over 12 per cent y-o-y.

Last week, however, saw has a five per cent rise in Brent crude futures.

If this rise is sustained, fuel deflation could reverse.

Food inflation was at double digits through much of 2013-14 and only came under control in the last quarter of calendar 2014.

There were apprehensions that prices would have spiked, given unseasonal weather.

But the food basket saw a moderate y-o-y change of 6.14 per cent in March.

Given a reasonable monsoon, food inflation should remain moderate.

Even so, poor agro performance is associated with low semi-urban and rural demand, along with higher food inflation.

Lower unit sales of tractors suggest rural/semi-urban demand is indeed low.

Let’s say that barring a poor monsoon and serious crude price rises, inflation stays under control.

The differential between CPI and WPI is high. This implies producers’ margins are improving.

They are only partially passing on the benefits of softer commodity prices. This could translate into higher profits.

Reactions to the inflation data have been interesting.

Many institutional analysts expect the Reserve Bank of India to cut policy rates, in its June 2 policy review.

However, we will see the April inflation data before that, and the full-year results for most banks.

The US Federal Open Market Committee is due to meet on June 16-17 and might decide to raise dollar rates (or not).

It is possible RBI will just wait on June 2, and go out-of-turn with a late June cut if the FOMC statement is suitable. 

Meantime, the disconnect between bank share valuations and fundamentals is striking. The Bank Nifty is up 48 per cent in the past 12 months (the Nifty is up 29 per cent in the same period).

But banks are struggling to cope with low demand for credit and sticky loans.

Gross impaired assets could hit 13 per cent of total assets by March 2016, according to India Ratings & Research.

The International Monetary Fund says Indian banks are among the most vulnerable to losses among emerging economies.

RBI has changed the norms to allow for greater usage of counter-cyclical buffers for provisioning.

It has also insisted on higher provisioning for restructured assets from April 1.  

The Bank Nifty is valued at a weighted price-to-earnings multiple of 19.5, which is misleading due to calculation methodology.

There are six public sector banks and six private banks.

The private banks have higher weight, due to the free float methodology, since PSBs are very closely held.

The PSBs are traded at far lower valuations.

The PSU Bank index has a PE of 12 and many PSBs trade at single-digit PEs.

Private sector banks are valued much more highly.

But the PSUs control 70 per cent of total banking assets and have much more vulnerable balance sheets than private players.

Compliance with Basel-III capital adequacy norms has been postponed because the government doesn’t possess the resources to recapitalise.

The bank sector cannot really grow out of crisis purely on economic rebound. Much of the  money is stuck in stalled infrastructure projects, especially in power and in roads. The government will have to take hard policy decisions to try and clear the decks for implementation.

Failing that, it must find the quickest and least painful ways of shutting those projects. If resolution takes too long, banking could hit a big speed bump.  

The inflation data certainly indicates more rate cuts.

In principle, that must be good for banks. But the sector-specific problems are large and intractable.

Valuations have already priced in the hopes of substantial future improvements.