Tuesday, May 11

Real rates in India among highest: ICICI Bank

Mumbai: Real interest rates in India have been the highest across countries as well as over time as inflation has undershot targeted levels. According to ICICI Bank, the unexpected drop in international crude prices is likely to compel the RBI to change its stance from calibrated tightening to neutral.

“In India, we have been targeting inflation of 4% and the repo rate has accordingly been kept at two and half percentage points above this. But actual inflation has been much lower, resulting in high real rates,” said B Prasanna, head of markets at ICICI Bank. Real rates are the nominal rates adjusted for inflation, but they can be determined only for the past since inflation can be observed only in hindsight.

“Earlier, when the policy was targeting wholesale prices, there have been instances when real rates were negative despite repo rate being at 9% because of high inflation,” said Prasanna. He added that the present high real rates improve the attractiveness of Indian bonds.

Going forward, however, inflation is expected to firm up. ICICI Bank has forecast consumer price index (CPI) to average around 4% for the first half of FY20, but then pick up sharply in the second half. The key risks are a possible reversal in food prices and the government slipping on its fiscal deficit target.

The stress in the farm sector due to low food prices is expected to keep consumption demand in check. This will keep economic growth contained at 7.4% in FY20, which will be marginally better than the 7.2% forecast for FY19. This would be because the economy would have finished its transition to the goods & services tax (GST) regime, resulting in higher formalisation.

The biggest positive news this year, however, is the sharp fall in crude oil prices, which will result in balance of payments swinging to the positive. This, coupled with the likelihood of the US Federal Reserve pausing rate hikes, has turned out to be positive for the rupee, which has staged a smart recovery in recent weeks. “Performance of emerging market currencies against the dollar will be mixed and less vulnerable economies, with stable political set-up and current account surpluses, would be preferred. The fall in oil prices would also benefit high-yield current account deficit countries such as India and Indonesia,” said Prasanna.

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