Bumps ahead for bull run

RBI cut its median projections for gross value added growth for FY18 to 6.7% from 7.3%

The Monetary Policy Committee's (MPC's) decision to leave policy rates unchanged was expected. The Reserve Bank of India (RBI) cut its median projections for gross value added growth for 2017-18 to 6.7 per cent from 7.3 per cent. It expects inflation to range between 4.2 and 4.6 per cent in the second half of the fiscal. Upside risks to inflation include farm loan waivers and possible pay hikes to state government employees.

The central bank is a little apprehensive that inflation might overshoot. What's more, there's worry about currency turmoil. The dollar is weakening, the euro is zooming up, the yen is bouncing around and the pound faces Brexit-related risks. The rupee, like all emerging market currencies is sensitive to changes in stances in hard currency monetary policies.

Portfolio inflows are vulnerable to the normalisation of the US Federal Reserve's balance sheet. The Fed is expected to soon start selling its vast bond holdings and also raise dollar policy rates. This will lead to tighter money supply and higher dollar yields.

The RBI's pessimism is based on poor first quarter GDP growth, low estimates of kharif production and the initial adverse effects of GST (goods and services tax) implementation. Surveys show consumer confidence is weak. But, firms do expect improvement in business sentiment in Q3.

The manufacturing PMI saw expansion in August and September 2017 with new orders. Services provided a mixed picture. High speed data was also mixed. Steel consumption was robust but cement offtake was weak. Sales of commercial and passenger vehicles and two and three-wheelers was up. Railway freight traffic and international air traffic was also up. But, cargo at ports and domestic air traffic were weak.

The consumer price index (CPI) hit a five-month high in August, as favourable base effects ended. Food inflation rebounded. Fuel inflation rose somewhat, due to higher international prices. Core CPI inflation, excluding food and fuel, also increased in July-August and the increase was broad-based across goods and services. RBI surveys showed that respondents expect inflation to accelerate in the three-month timeframe and over one-year. 

The MPC statement emphasised the need to kick-start investment. It also mentioned the need to close the "severe infrastructure gap" by restarting stalled projects. It called for GST simplification and rationalisation of state stamp duty on housing sales.  

The Q2 data, including corporate results, will come in soon. Results are expected to be poor and may beat consensus due to the low expectations. Businesses have complained about a jump in working capital costs post-GST - let's see what shows up. 

High-speed data will be watched for signs of an uptick. Seasonal adjustments for festivals will be tricky. The Durga Puja and Diwali both fell in October 2016, which meant many holidays and a consumption bump in that month. The September 2017 Index of Industrial Production (IIP) may be weak, since September 2017 hosted Durga Puja /Dussehra with attendant holidays. But, October 2017 could see a spike. Similarly, consumption may spike in September versus a fall in October.

The rupee may face volatility through Q3, due to external factors. Slow GST credits may have retarded exports in the October-December 2017 period. But, a lower rupee could create better prospects. The MPC's status quo means that domestic interest rates and rupee treasury yields won't move much until December. 

That's when the MPC meets again and by then, the Fed's actions and timelines should be clearer. The markets shrugged off this Policy Review. But, there could be a drop in FPI (foreign portfolio investor) interest in November-December if the Fed launches normalisation. Retail investors have been known to ease off activity in the post-Diwali period. So, there could be some adverse impact on the bull run in the latter half of Q3.