Watch the numbers of auto and consumer durable companies carefully

The Reserve Bank of India is presumably, betting, the rupee won't weaken more, or even that it will rebound

The Monetary Policy Committee’s (MPC’s) decision to hold policy rates at the last review surprised the markets. There is some underlying justification.  There has been a focus on currency and energy markets. But other commodities’ trends have slipped under the radar.  Metals are bearish and so are agro commodities and that balances off higher energy costs to an extent. 

Hence, inflation has stayed benign. At first sight, that's a paradox. Given India's high exposure to trade, a weaker rupee and higher import tariffs, the inflation trend line should go north. But food inflation is low and food is about 45 per cent of the retail basket. 

The Reserve Bank of India (RBI) is presumably, betting, the rupee won't weaken more, or even that it will rebound.  In the meantime, holding rates would, at the least, not impede consumption. And consumption will be a vital component of Gross Domestic Product (GDP) growth if the government is serious about sticking to fiscal deficit targets. 
 

The Indian crude basket was at $67/ barrel in January and it’s above $80 in October. The average cost for this fiscal (April-Sept 2018) is $73.7/ barrel, while last fiscal (2017-18) averaged out at $56 - that’s a 30 per cent rise. In addition, the rupee has fallen roughly 17 per cent since January. Gas is up by around 14 per cent in the past three months and about 25 per cent since January — (gas prices are more variable than crude). 

India's economy responds predictably to higher energy costs. There is pressure on the currency, while the trade deficit and the current account deficit (CAD) tend to widen. Most estimates for the CAD in 2018-19 are now in the range of 2.5-3 per cent of GDP.  In addition, there is inflation due to costlier imported raw material inputs. This also tends to hit consumption as buyers react to higher prices. GDP growth can stall as a result. 

In current dollar terms, GDP growth will probably be negative for the fiscal year but it's positive in rupee terms. GDP growth depends on two things - government expenditure and private consumption.  The former cannot be hiked without pushing up the Fiscal Deficit (FD). The latter would be negatively impacted by higher interest rates and higher prices. 

This being an election year, poor government policy is guaranteed. The government will spend a lot of money on unproductive things and of course, political campaigning will flood the economy with black money.  But that could boost consumption, as well as push up inflation. 

The government has gone into panic mode to address public sensitivity on energy inflation. It has re-imposed price controls on oil-marketing public sector oil companies. This is poor policy. Another element of poor policy is higher import tariffs on a wide range of items. Even if there are domestic alternatives, local manufacturers will now jack up prices to take advantage of the protection. 

One saving grace could be the falling metal costs.  Every non-ferrous metal, except zinc, has lost ground in the past three-six months. That’s due to the trade war squeezing Chinese demand. Agricultural prices for almost all commodities also remain soft, domestically and globally.  

Those softer prices are balanced to an extent by the weaker rupee. But the domestic steel sector, for example, is profiting from import barriers, which means users down the line are paying higher prices than they would if cheap imports were allowed. Those higher costs will be passed onto consumers. This is already visible in the auto-industry, for instance, since manufacturers are hiking prices.   

   

The MPC may have made the wrong decision due to two reasons.  The rupee could be sold down further, given global turmoil. The import tariff policy will guarantee some inflation, and that too could accelerate as crude climbs.  

While there will be snapbacks, the rupee is not likely to strengthen much from here, so long as crude prices remain high and crude will stay up due to the Iran situation. The trader will have to take a view on industrial metals. Those are likely to stay down but there is frantic lobbying from the domestic metals industry for ‘protection’.

Consumption in the next two months will be crucial. Most households do their big-ticket buying during this season. If consumption stays strong, GDP growth will be okay. If consumption weakens, the fiscal deficit will expand and all budgetary assumptions will go awry.  Watch the auto industry and consumer durables numbers carefully.