India's bank note reform may reduce inflation further: Singaporean bank

Development Bank of Singapore, however, cautioned that the move is likely to hurt consumption

India's bank note reform has pushed up deposit growth and boosted liquidity that may, in turn depress, inflationary pressures, the Development Bank of Singapore (DBS) said on Thursday.

"The banknote reform has pushed up deposit growth, which in turn has boosted liquidity," said DBS in its daily market report.

With credit growth still weak, excess liquidity has pushed Indian ten-year bond yields sharply lower this week. This is in contrast to Asian price action, observed DBS.

Markets' based borrowing rates and banks' lending rates are also softening, it said.

Alongside the liquidity boost, the banknote reform is expected to depress inflationary pressures. This is in addition to the already positive inflation trend, the bank said.

In October, inflation eased to 4.2 per cent year-on-year from a peak of 6.1 per cent in July this year.

Easing food inflation was the main drag, in turn entirely due to a sharp fall in vegetables and pulses, while other segments were little changed, said DBS.

Core Consumer Price Index (CPI) inflation (ex-food and fuel) has been fairly steady within the 4.5 per cent to 5.0 per cent range for nearly a year.

In light of a normal monsoon, smaller rise in minimum support prices and administrative steps undertaken by the government, food inflation is likely to stay below 5 per cent this year, according to DBS.

Global crude prices are up since the nadir in January this year, but have struggled to gain ground on an uncertain supply outlook.

From the demand end, the recent banknote reform is likely to hurt consumption, it cautioned.

"This, to some extent, will off-set the lift from higher public sector wages, posing downside risks to our inflation estimate of 4.8 per cent for the year," it said.

The positive inflation path and RBI's lower real rate threshold, along with their lack of committment to the 4 per cent inflation target in the upcoming financial years leaves the room for a 25 basis points (bp) cut in the first quarter of next year.

Contingent on the inflation outlook, odds for another 25 bp cut within first half of next year (1H17) will also rise, it believes.

A cut in the December meeting, however, looks unlikely after the pre-emptive rate cut in October and volatile financial markets amidst rising external uncertainties.

The Indian rupee tumbled to a five-month low on Wednesday, within striking distance of the 68 handle, while equities struggled to retain gains, noted the bank.

Until the currency crunch is resolved, more payments are likely to be settled through electronic modes of payments, plastic money and e-wallets, amongst others, believes DBS.