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This is going to be a crucial week for the markets. Three critical pieces of data - inflation, industrial growth and trade deficit - will have a bearing on the central bank's decision on any rate cut. The trade deficit for February has come in at $15 billion, which is well below the estimated $18 billion. Despite this, the current account remains vulnerable.
However, it isn't clear how the deficit data will be interpreted by the Reserve Bank of India (RBI). While one set of economists believe that a widening current account deficit (CAD) may force the central bank to ease rates, another set believes that it may delay easing further. Tirthankar Patnaik of Religare Institutional Research says: "Amidst burgeoning trade deficit figures, sustained strong capital flows remain very critical for the capital account and the rupee."
Apart from persistently weak deficit figures, industrial production is also expected to be weak. The index for industrial production (IIP) is expected to improve marginally from the 0.6 per cent contraction seen in December. The eight core industries basket, which constitutes 37 per cent of the IIP basket, has grown 3.9 per cent in January. Poor demand for automobiles and cement also suggests that industrial output is not on the upswing. Finally, inflation would be a key determinant for any rate action.
While WPI inflation is expected to largely remain static at 6.6 per cent levels seen in January, any downward move "would be another bolster for rate cut expectations," says BNP Paribas. So far, the recent increase in power tariffs and diesel is not reflected in the inflation rates but it will be visible from H2 2013. This gives RBI a narrow window to act on rates, before inflation spikes up.
Consequently, the market is factoring in a rate cut of at least 25 basis points in March. Both fixed income strategists and economists believe it's only a matter of time before RBI steps in to support growth. The worst may be over, but any recovery hinges on easing, as it would have a cascading effect on the economy. A rate cut would not only improve corporate profitability but would also help attract portfolio flows that India desperately needs to fund its CAD.
Bank of America Merrill Lynch believes RBI will need to take more pro-active steps to attract capital inflows. It sees three options to fund the yawning CAD. Easing is the first, re-issuing NRI bonds is the second and raising foreign institutional investor limit in debt is the third option. Given that inflation is expected to spike in the second half of the calendar, easing rates appears to be the best bet as of now.
