13 February 2018
India’s growth has gained some traction

The balance of economic risks remains tilted toward inflation   

Stubborn inflation

India’s consumer price inflation eased in line with the consensus to 5.1% year-on-year in January from 5.2% in the previous month. The seasonal month-on-month dip in food prices outweighed higher housing and transport prices while most other CPI components but for fuel posted month-on-month increases. The data is consistent with the Reserve Bank of India’s (RBI), the central bank, forecasts for 5.1% average inflation in the current quarter, up from a 4.6% average in the previous quarter.

January’s slight slowdown in inflation doesn’t offer much hope of a lasting relief from inflation. The RBI has warned of continued upward inflation pressures this year from persistent high food and oil-related components, hikes in housing allowance for civil servants, higher customs duty on several imported products, the fiscal overrun, and rising inflation expectations. On the RBI’s forecast, inflation could accelerate to as much as 5.6% in the first half of FY2018-19, followed by some moderation to 4.5-4.6% in the second half.

But some good news on growth

Also released yesterday, industrial production growth in December was better than expected at 7.1% YoY (consensus 6.0%, ING 5.6%), while the November reading was revised up to 8.8% from 8.4%. The 5.9% IP growth in the October-December quarter was up from 3.3% in the previous quarter, pointing to an acceleration of GDP growth over the same period. This data imparts some upside risk to our forecast of a modest pick-up in GDP growth to 6.5% in the October-January from 6.3% in the previous quarter (consensus 7.0%, data is due February 28).  

Little policy leeway for the RBI

Growth has gained some traction but economic risks remains tilted toward inflation. With rising government borrowing constraining monetary tightening, our baseline for 2018 remains no change to RBI rate policy.

China: Shadow banking shrinking

China's loan data shows that shadow banking is shrinking, this could be the result of financial deleveraging reform. We expect the reform to continue for the rest of 2018

China may have succeded in reining in shadow banking

Data released by the Chinese central bank (PBoC) reflects that core shadow banking items shrank in total social financing, a measure of standard banking plus shadow banking activities. Meanwhile, loans going to standard channels, namely, new yuan loans grew 40% year-on-year to CNY2.69 trillion and contributed 87.9% of total social financing.

Even though banks are usually eager to book loans at the beginning of the year in order to enjoy a full year of interest income, it seems that financial regulators, including the central bank, the banking regulator, insurance regulator and the securities regulator, have gained some success in limiting shadow banking activities. New trust loans fell to CNY45.5 billion, and new entrusted loans contracted by CNY71.4 billion, which resulted in a 17%YoY reduction of total social financing.

Implication for 2018 - tightness of liquidity to continue

The change in the structure of total social financial shows that the impact of financial deleveraging reform may have started to kick in. We expect yuan loans to continue to grow faster than shadow banking items in 2018. We believe that this is only the beginning of financial deleveraging in China. This success needs further policy consolidation.

It is therefore likely that the central bank will tighten liquidity for the rest of the year. The recent temporary liquidity injection was to avoid spikes in short-term interest rates around the Chinese New Year. After the Chinese New Year, we expect to see more regulations on financial deleveraging. And that could be the result of tighter liquidity through daily open market operations.

Aside from tightening through daily liquidity management, we expect the central bank to follow the Fed in raising interest rates (or the 7D reverse repo rate) three times in 2018. But as liquidity tightening could have already pushed up short-term rates by then, the magnitude of the PBoC's rate hike could be as mild as five basis points, the same as the December hike.

This is to make sure that the PBoC would not create an environment where interest rates in China are too high. It is true that financial deleveraging needs higher interest rates to drive out poor quality corporates and financial institutions, so the regulators would also be careful enough not to create a liquidity or credit crunch.

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Good MornING Asia - 13 February 2018

Saying that bonds are past their peak is not a useful contribution to the question of whether we are nearing a recession. Sadly, little else is either.

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