CPI inflation may undershoot RBI target, interest rate cuts possible: Kotak MF

Lakshmi Iyer

October 2017 monetary policy is on the anvil. Even at the best of times it has never been easy to read the mind of the policymakers. But this time, it is especially a hard task. The CPI-based inflation rate that was curbed with much discipline and effort; is now again beginning to show signs of uptick. It is not hard to discern why the CPI inflation is on a rebound.

The teething troubles of GST related issues have impacted the supply side of the economy. While we are sure that the issues may be resolved soon, yet the price impact has been felt already. To add to that, the rains while largely satisfactory, have still been deficient in parts of Madhya Pradesh, Uttar Pradesh, Haryana and Punjab.

This may have also impacted the agriculture prices from time to time. To add to that, the WPI is also on the uptick on account of the low base effect. This too may have had its impact on the CPI. With already a rate neutral stance, these data points don’t indicate an optimistic scenario.

But a different picture is visible if we look at the need to stimulate growth. Some moderation in the GDP growth in Q1 FY18 was expected. But the growth rate of 5.7% was a bit of a surprise. This has made the need for pro-growth policy measures imperative. Moreover, while the inflation has blipped up, India still remains one of the few predominant economies with high real interest rates.

This has attracted foreign capital and has increased the Rupee valuation. High rupee has, in turn, affected our exports and has increased our current account deficit. For that reason, the need for a rate cut seems much more pressing. Given the fact that the CPI inflation may undershoot the RBI target, gives more hopes of rate cuts going ahead. We believe that there is scope for additional easing, though the timing could be more gradual.

Given the uncertainty surrounding the upcoming monetary policy, many investors may be preferring the accrual funds. Accrual funds invest across the credit rating spectrum thereby having a relatively higher portfolio yield. The portfolio duration is usually on the lower side to reduce interest rate related volatilities.

Investors unwilling to assume the credit risk and duration risk could also look at investing in high quality short term funds that provide relatively reasonable yields and moderate duration. Finally, we believe that interest rates in India could be range bound with a benign bias. It may not be a one way downward movement, hence prone to periods of volatilities too. There is a case for fixed income allocation based on the varying risk appetite of the investor.