Monday, April 29, 2013

Monetary policy in India and Brazil

In India further interest rate cuts seem more likely following the recent sharper-than-expected decline in the Wholesale Price Index (WPI).  WPI inflation fell to 6.0% y/y in March, down from 6.8% in February.  Core inflation also continued to decline, falling to 3.5% y/y from 3.8% y/y over the same period.

I’ve written before about the tension between the Reserve Bank of India (RBI) and the Government with the former looking for changes to fiscal policy (subsidies) and structural goods markets reform to ease inflation pressure with the latter looking for the RBI to do more work to support growth, which at 4.5% in the year to December 2012 is below trend. 

However, with WPI inflation now lower and growth looking soft, there is more room for the RBI to move.   However, we think the RBI’s comment from their last statement still holds: “the headroom for further monetary easing remains quite limited”.  That’s particularly the case given that CPI inflation remains in excess of 10%.  We think there is room for another 50 bps of easing with the next move likely to come at the policy meeting on May 3rd.

In Brazil, the central bank recently raised the official Selic rate by 25bps.  With the Brazilian economy slowing more sharply than we expected last year, the central bank eased aggressively.  The policy rate ended up lower in 2012 than it was during the GFC downturn.

With that aggressive monetary response, we warned the central bank would have to respond quickly to signs of emerging inflation pressures.  That seemed inevitable given the near 20% depreciation in the Brazilian Real.  While recent activity indicators have been somewhat softer than expected, inflation has surprised on the upside.

The good news is the Bank is responding to the inflation surprise.  While we expect to see interest rates move gradually higher in the period ahead, we are not expecting an aggressive tightening in conditions.  At this point I’m still happy with my 2013 GDP growth forecast of 3.0%.