India Prepares for Trade Wars

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oi-Staff

By Roopa Upadhya

Updated: Friday, August 3, 2018, 8:47 [IST]

Every year India looks forward to the monsoon with a nervous anxiety. Not due to the unending traffic chaos and water logging it creates in the metros; which is a story for another day; but due to its direct impact on the India economy. Governments' performances are largely dependent on the rain gods showering its mercy on the non-perennial rivers and having ample Kharif crops on which two third of India depend on.

Thankfully for all of us, this year the onset of the monsoon has been both on time and largely on expected lines.

Coming to the economy, the Reserve Bank of India (RBI) on Wednesday August 1st announced a 25 bps hike from 6.25% to 6.50%. This was the second consecutive rate hike, the previous being a 25 bps hike in June. It is widely believed that this measure was taken in order to offset inflationary pressures that is expected to arise due to the raising of MSP by 150%.

The raising of Minimum Support Prices (MSP) by a significant margin, far more than usual; will have near term pressure on food inflation. However, with good monsoons occurring all over the country the problem will be somewhat contained.

A rising crude too has made the central bank jittery and in order to avoid falling behind the yield curve the RBI has wisely chosen to be proactive with the monetary policy. The GDP forecast was retained, and the central bank has adopted a "Neutral stance" to give itself sufficient flexibility in future monetary policy.

The most prevailing concern which was cited in the monetary policy statement was the imminent trade wars that has been triggered by USA and countered by China and EU. A consequent reaction to imposition of trade tariffs has been an aggressive devaluation of currencies by many economies around the world. A sustained currency war among the major economies will be terrible for inflation and will lead to overheating of commodity prices which acts as significant headwinds to the Indian economy.

Also, note that we are within one year of the next Lok Sabha elections and the Government will want to have a strong hold over inflation, lest it's positive work in keep inflation under tight control gets ruined when it matters most - close to when it goes to the people for votes.

One counterbalancing force which will support prices from inflating away is the lowering of the GST rates on several goods and services. This will help dampen the impact somewhat on inflation. Rural spending has been going up for several quarters now which is reflected in double digit growth numbers for the June quarter in two wheelers for Hero(NSE: HEROMOTOCO)

The Indian Rupee has been making new lows every other day against the USD and RBI has been very keen on ensuring it doesn't depreciate further. An expected FED hike by the US central bank in their next policy summit would also have been in the committee's mind while deciding on the rate hike yesterday.

Considering all these factors and also the structural changes brought in by this Government-whether it is GST, Bankruptcy code or the digitization of the economy; India is poised to perform well over the next few quarters running into the elections. We may start experiencing caution amongst investors closer to the beginning of the next fiscal year as election season will be fully upon us.

Roopa Upadhya is a senior Management Consultant at UBS, New York who helps customers understand and implement FED policies.

Disclaimer: I do not own any stock that is mentioned in the article and the article is not to be taken as investment advice.