India: Interest rates, inflation and manufacturing ambitions

Dr Mark Mobius, Templeton Emerging Markets Investment Trust

This year the global financial markets have been largely focused on China’s growth story and the US Federal Reserve’s possible monetary policy actions. Many investors may not realize that India—the world’s third-largest single economy based on purchasing power parity—is expected to have a higher growth trajectory than both China and the United States this year and next.

With very high interest rates in India and the effort to bring them lower, inflation is a hot topic. The Reserve Bank of India (RBI) has always been reluctant to lower interest rates in the face of high inflation, but there is considerable confusion about inflation in India.

Looking at India’s wholesale price index (WPI), it would seem that the country is in a deflationary mode since the reading on that index was -4.54% as of September 2015. However, inflation as measured by the consumer price index (CPI) was +4.41%, as of September 2015.3 This gap is a concern to anyone looking at the inflation numbers and trying to make sense of them—as well as what the market implications may be.

Members of the Indian government and some prominent businessmen have complained about high interest rates, but RBI Governor Raghuram Rajan had been reluctant to lower interest rates too quickly and too much, fearing inflation could flare up.

The RBI acquiesced on September 29, lowering its key lending rate to 6.75%, the fourth rate cut this year. In its official statement, the RBI cited downside risks to growth and a drop in the headline CPI in August to its lowest level since November 2014.

However, the RBI also noted that inflation is likely to go up going forward—at least for a few months—as some favorable effects seem likely to reverse. I think the RBI will remain very cautious going forward in terms of lowering interest rates further, but a lot will depend on domestic inflation, and whether economic growth accelerates or ebbs.

There’s no question that since 2013, both consumer and wholesale prices have come down substantially in India. However, there is a realization that the WPI is quite different in composition from the CPI. The WPI is focused on prices of tradable goods such as fuel and steel, which have fallen dramatically on international markets.

The CPI is more focused on items such as food, beverages, housing, utilities and clothing, where international commodity price movements do not have as big an influence, at least in the short term.

The debate continues, but the falling trend in both inflation indices augers well for Indian interest rates, and we think this should be supportive to India’s equity market—assuming there are no unexpected external shocks.

High hopes for change

When the new government was elected in the spring of 2014, it seemed everyone was excited about India’s prospects, and India’s stock market surged in the aftermath. While sharing the people’s optimism, we knew it would be difficult for all Prime Minister Narendra Modi’s talked-about reforms to actually get implemented.

However, the measures we have seen so far have been good, and any steps that India can take in the right direction are welcome to us as investors. Certainly, we would have loved to have had all of Mr. Modi’s promised reforms implemented immediately, but recognize it is a difficult task when opposition parties—which have stymied some of the legislation—have to be brought on board. Even if Mr. Modi achieves a smaller fraction of his promised reforms we would see that as success.

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