India: Higher growth, lower inflation – Nomura

India’s CPI inflation moderated to a lower-than-expected 4.4% y-o-y in February from 5.1% in January, driven by lower food price inflation (to 3.3% from 4.7%), as the delayed seasonal drop in vegetable prices continued, but the drop in food price inflation was broad-based, points out the research team at Nomura.

Key Quotes

“Core CPI (ex-food and beverages, fuel) was unchanged at 5.2% y-o-y, but other underlying inflation measures moderated to 4.1-4.3%. Sequential momentum eased in a number of core categories in February, suggesting good internals.”

“Industrial production (IP) growth surprised positively, increasing to 7.5% y-o-y in January, on the back of strong 7.1% growth in December and a 25-month high of 8.8% in November. The pick-up was broad-based, with consumer durables recording breakout growth of 8% y-o-y after over a year of uninspiring performance, while double-digit growth continued in capital goods output.”

Does this change your economic view? No, although lower headline inflation and good core internals offer some near-term comfort; but risks from higher minimum support prices (MSP) remain. The continuing impressive IP performance reinforces our expectation of a strong cyclical V-shaped recovery. Recent banking sector developments are a downside risk, but leading indicators suggest a continued uptick in growth for now. Q1 inflation (at ~4.6%) will undershoot the RBI’s projection (5.1%), but inflation is evolving in line with the RBI’s projected trajectory in FY19: 5.1-5.6% in H1 (Apr-Sep) and 4.5-4.6% in H2 (Oct-Mar).”

“The coming quarters will be more challenging for monetary policy. We expect rates to remain on hold throughout 2018 because of (1) banking sector risks, and (2) underlying inflation at ~4.3%, implies a sufficient real rate cushion. However, we expect more hawkish rhetoric in Q2, possibly via a change in policy stance, when headline growth/inflation will be higher. Higher-than-expected MSPs, a rise in underlying inflation and higher oil prices would shift risks towards tightening.”

Strategy implications: Rates strategy: Today's lower headline inflation and stable core inflation print is a positive outcome for rates markets. We maintain our recommendations of long IGB 6.84 2022 and a 2s5s NDOIS flattener. FX strategy: The combination of higher IP and lower inflation could support INR in the short term. That said, given our current concerns over the global backdrop, including from US trade tensions and monetary policy, and some local concerns stemming from a widening current account deficit, and fiscal and political risks, we remain cautious on INR.”

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