As expected the Reserve Bank of India left its refinancing interest rate unchanged at 8%. However, the RBI cut banks’ statutory liquidity requirement by 100bp to 23%. This is aimed at increasing banks’ lending capacity. However given the global economic backdrop and weak investment conditions the impact on kick starting economic growth is likely to be small. The RBI appears reluctant to cut interest rates at the moment, saying it will only exacerbate inflationary pressures rather than support growth. However, ultimately we believe that growth concerns will lead to a 50bp reduction this year.
As a strong export dependent economy, South Korea is suffering more than most from a fragile external environment. Exports fell 8.8% y/y in July, down from June’s 1.1% rise. July’s weak new orders for the US and euro area suggest there is little relief in sight. Domestic demand has also show signs of easing and with July’s consumer price inflation surprising on the downside – 1.5% y/y its lowest rate in more than twelve years- there is scope for further interest rate cuts. We expect the Bank of Korea to follow up from July’s 25bp cut with an additional 25bp next Thursday.
THE WEEK AHEAD
A sharp deceleration in Chinese consumer price inflation from a cyclical high of 6.5% in July to 2012% in June has given the authorities scope to reduce bank reserve ratios three times since December and cut interest rates twice in June. July’s CPI print is unlikely to prove a barrier to further interest rate reductions, with inflation forecast to rise only 1.6% y/y – the lowest rate since January 2010. However, the PBoC will be conscious that this partly represents base effects with the strong July 2011 outcome. Moreover, the recent surge in global wheat, soybean and corn prices raises the risk that inflation could accelerate sharply (food accounts for 30% of the CPI basket). We believe the PBoC will lean towards reducing bank reserve ratios (another 100bp forecast for H2), and we also forecast one more interest rate cut.
Chinese policy has also focused on increasing infrastructure investment. Local governments have announced initiatives to boost consumption and investment. This will see investment accelerate in H2, although given the financial constraints most local governments we do not believe that all projects will come to fruition. We look for fixed urban investment to increase to 20.6% ytd y/y in July from 20.4% in June. Consistent with this modest increase in investment we look for industrial production to rise to 9.8% y/y in July, up from 9.5% previously. This will be in line with our GDP growth forecast 8.2% y/y for H2 (compared to 7.8% y/y in H1). Nonetheless, reports of job losses have cast a cloud over the outlook for household spending. While we expect retail sales growth to be unchanged from June at 13.7% y/y in July, the pick up in sales growth is reflecting base effects and may slow sharply in the coming months if job losses continue. China also faces external headwinds. Weak demand from the euro area is contributing to slower export growth. However, while official figures suggest that import growth has weakened substantially this year we believe that these maybe understated. Analsying trade data from countries such as Australia suggests that the slow down in Chinese demand for raw commodities has been less than the Chinese figures would suggest. That said, imports for reexporting are expected to be weak. We look for China’s trade surplus to narrow slightly to US$31.2bn in July, from US$31.7bn in June
The Indonesian economy is forecast to grow 6.2% y/y, from 6.3% previously. Although domestic demand is expected to have recorded another solid quarterly growth, it has also led to a sharp rise in imports. When coupled with sluggish exports we expect net trade to be a key drag on GDP growth in Q2 and for the next couple of quarters. Notwithstanding, the external headwinds facing the Indonesian economy we expect interest rates will remain unchanged at 5.75%.
Russian GDP is expected to have grown rose 4.3% y/y in Q2, from 4.9% in Q1. This is slightly higher than the estimate announced by the Russian Finance Ministry last month. Government spending is expected to have recorded another solid quarter of growth while retail sales data suggest consumer spending was a key contributor. However, industrial activity appears to be stuttering. Output growth moderated to 1.9% y/y in June, from 3.7% previously, with more externally exposed industries struggling due to weaker global demand. Downgrades to our global economic forecasts suggest little relief in the coming quarters. Indeed prospects could deteriorate unless a sustainable solution to the euro area crisis ensues. We expect GDP growth of 3.7% this year, however it will ultimately depend on the oil price.