No interest rate shocks expected

In the last few weeks, one of the most important topics for discussions has been “Is inflation peaking out?” But, let us first look at the current background of high single-digit inflation. In our opinion, the current high single-digit inflation is due to high food prices (due to a poor monsoon), base effect and demand revival. Out of the three factors, the first two factors had a major impact on inflation.

Primary articles index (22.02 per cent weightage in the wholesale price index) increased an average 0.9 per cent month-on-month in the last eight months. Fuel, power and light index (14.23 per cent weightage) increased 0.8 per cent month-on-month and manufacturing index (63.75 per cent) increased 0.5 per cent month-on-month.

Again, the rise in manufacturing index was primarily due to food products, a sub-component of the manufacturing index rather than demand side pressure. Therefore, whatever rise in inflation we have seen is predominantly from supply side rather than a demand revival.

Is inflation close to peaking out? We think it is.

First, we have a better monsoon forecast. India’s weather office has already forecast a normal June-September monsoon this year after the 2009 season saw the worst drought in nearly four decades. Therefore, the pressure from rising food prices will abate gradually, but surely.

Second, the potential threat from rising crude oil prices. Looking at the current economic crisis in Europe, we feel that the probability of a rising oil price is very low. Third, the Commodity Price Index and metal prices have corrected significantly in the last few weeks due to a risk aversion caused by the Europe crisis. Fourthly, due to the ongoing EU crisis, the dollar will strengthen, which will help India. A strong dollar can act as a natural hedge against rising oil, commodity and metal prices.

RBI has started the interest rate normalisation process. Given the current backdrop of inflation peaking out, recovery in growth, reviving credit offtake and global uncertainties, we feel RBI will adopt a slow and gradual process of hiking policy rates. The recent uncertain global environment further reinforces our view of taking smaller policy actions.

What is the impact of this? We feel the overall interest rate scenario will be conducive to growth, support credit offtake and control inflation. Banks will not hike lending rates sharply as credit offtake is still reviving. Thus, there will be no interest rate shocks for various types of participants, such as corporates, individual borrowers and investors. This, in turn, spells good news for the economy and markets.

The author is CIO, JPMorgan Asset Management India