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India cuts interest rates, but not enough

India CPI and Policy Rates 2013-03-23Enlarge Graph

The Reserve Bank of India (RBI) just announced a cut of 25bps to their repo rate, but economists and investors wanted more.

India is in a similar situation as Russia, persistently high inflation and sluggish growth. India’s GDP growth made new lows when it slowed to less than 5% during the last quarter of 2012; this value is the lowest since the global recession three years ago.

India has been facing high inflation, though the RBI has maintained a dovish1 view to avoid a further slow down of the economy.

The repo rate was cut just 25bps to reach 7.5%. In its outlook report, the RBI stated that further easing is quite limited given the inflation levels, which are “not conducive for sustained economic growth.”

The Indian government got itself into an inflationary mess when it decided cut the subsidy of diesel in mid-September last year to reduce the fiscal deficit, saving almost $6bn per quarter for state-run companies, but unleashing inflation across the economy. Wholesale inflation was almost 7% in February, way above RBI’s 4-6% target range. The food-only component of inflation was 11.4% in February, which is naturally affected by increased fuel prices due to transportation costs and has further social implications considering that almost one third of India fall below the international poverty line of $1.25 per day2.

While the data overall paints a negative picture for India and investors in Indian equities ETFs (e.g. EPI, INDY, PIN, SCIF, INP), the market is currently trading at a very cheap valuation. In the short term the macroeconomic indicators do point towards lower levels, but in the medium term the market may offer a buying opportunity.

  1. Preference towards low inflation rates to promote growth despite inflation. In contrast to a hawkish view, which sacrifices growth in favor of maintaining inflation under control
  2. Purchase power parity adjusted