What Brokerage Houses Expect From The RBI Monetary Policy Review
The fall in inflation has opened up room for a 25 basis point rate cut
Urjit Patel, the 24th governor of the Reserve Bank of India, will present his first monetary policy review on Tuesday. The policy decision, to be released at 2.30pm, will also be the first to be taken by a monetary policy committee.
The review comes at a time when retail inflation has fallen to 5.05 percent, close to the central bank’s target of 5 percent for March 2017. High frequency growth indicators, such as the Index of Industrial Production, however continue to indicate weakness. Given that, some economists expect a 25 basis point cut in the benchmark repo rate to 6.25 percent while others are expecting a rate cut later in the year.
Growth-Inflation Mix Warrants October Rate Cut: Citi Research
The decline in consumer price inflation in August has opened up room for a 25 basis point cut on 4 October, wrote Samiran Chakrabarty and Anuraj Jha, economists at Citi Research in a note on September 17.
After hitting a 22-month high of 6.1 percent in July, India’s CPI inflation dropped sharply to 5 percent in August. The decline was led by lower prices of vegetables and a moderation in the inflation rate in the pulses category.
Citi noted that there has been a steady deceleration in CPI momentum since June with the CPI index falling by an average 0.2 percent month-on-month in the last three months. It added that retail food price data suggests a further moderation in inflation levels in the coming months.
“August CPI has opened up the possibility of a 25 basis points rate cut in the October 4 policy as the ‘upside risks’ envisaged by the RBI to its March’17 CPI target have substantially diminished now. On the back of the soft economic activity data – Q1FY17 GDP at 7.1%; July IIP contraction of 2.4%YoY – and stabilization of CPI within the target range, the RBI can bring forward another 25 basis points rate cut in the Dec policy as well.Citi Research
Citi, however, added that sticky core inflation and the current framework of maintaining a real rate of 1.5-2 percent could limit rate cuts beyond 50 basis points. Apart from rate easing, the RBI’s focus will also be on better transmission of policy easing into bank lending rates, the research house added.
With Some Luck, Core Inflation Could Also Soften: HSBC
Falling food prices, through the expectations channel, could gently soften stubbornly high core prices, wrote Pranjul Bhandari and Dhiraj Nim of HSBC in a note ahead of the policy.
According to HSBC’s analysis, the significance of the output gap (gap between potential and actual growth) in determining inflation has reduced while the role of food prices in determining core prices has risen meaningfully. This could mean that if food prices drop in a sustainable way, core inflation could also soften.
How much in rate cuts can we expect in the foreseeable future?
The RBI has two objectives – to reach its 5 percent inflation target in early 2017 and keep real rates at the 1.5-2 percent range. Marrying the two would open up space for easing by 50 bps. We expect a 25 bps rate cut at both the December and February policy meetings.Pranjul Bhandari, Chief India Economist, HSBC
Still, HSBC adds that there is some probability of a rate cut at the October 4 meeting. If there is no rate cut, HSBC expects the commentary to be dovish, with the RBI highlighting downside risks to its inflation forecasts.
Furthermore, we also expect it to continue to infuse liquidity into the banking system by buying dollars and government bonds, said HSBC
Liquidity Easing To Remain Key Focus: Kotak Mahindra Bank
Markets remain divided on the likely actions ahead of the first RBI policy of the new Governor Urjit Patel, especially when the decision is expected to be MPC-based and the stance of the newly appointed external MPC members remains unknown, said Upasna Bhardwaj, senior economist at Kotak Mahindra Bank.
According to Bhardwaj, the macroeconomic environment has turned quite conducive with the inflation trajectory, especially food prices, trending sharply lower.
We continue to see room for further easing of rates in the latter part of the year. However, we expect RBI to refrain from easing just right away and instead focus on removing the hurdles to smoothen monetary policy transmission further in the current policy.Upasna Bhardwaj, Senior Economist, Kotak Mahindra Bank
The RBI may also want to tide over the uncertainties related to FCNR outflows, US Presidential elections and be watchful of the recent surge in oil prices, added Kotak Mahindra Bank.
“In terms of liquidity management, while RBI has been focusing adequately on maintaining comfortable levels of liquidity in the system, we expect more aggressive action ahead of the FCNR outflows in October-November (of approx. US$ 20 billion),” said Bhardwaj. She explained that liquidity conditions are likely to tighten significantly in the third quarter amid FCNR outflows, seasonal pickup in currency in circulation and lower government spending.
Bhardwaj added that as FCNR deposits mature, banks have started to replace equivalent amounts of FCNR deposits with domestic rupee deposits in order to maintain the asset base. This may prompt domestic money market rates to harden marginally and hamper the transmission mechanism of the RBI.
Overall, Kotak Mahindra Bank is awaiting clarity on the newly appointed MPC’s views on monetary policy stance, especially when there is reasonable degree of flexibility while deciphering the inflation target.
We retain our call of a 25bps rate cut in calendar year 2016, with a higher probability assigned to a cut in December and expect the RBI to provide adequate domestic liquidity to improve transmission. Further room for accommodation can open up in calendar year 2017 depending on the interpretation of the flexible inflation targeting and the projections of the inflation trajectory in fiscal year 2018.Upasna Bhardwaj, Senior Economist, Kotak Mahindra Bank
Global Factors Apart From RBI Policy To Determine Rates: India Ratings
India Ratings and Research (Ind-Ra) expects two major factors to determine direction of the domestic interest rate market in the near future. These are the scope for incremental open market operations (OMOs) and global rate markets.
The overall liquidity condition in the Indian market has improved remarkably clocking surplus of Rs 1 trillion (1% of net demand and time liabilities - NDTL), primarily driven by OMOs. The yield curve has come down by 75-125 basis points since April, without any rate cut since April.
Since large FCNR accounts are due for redemption in October and November, scope for OMOs cannot be ruled out in these months, said Soumyajit Niyogi, Associate Director - Credit & Market Research Group at India Ratings.
“However, the quantum will depend on forex flows, which also depends on the global risk appetite. In this context, the referendum in Italy and US elections in early November will be the events to watch out for.”
According to Niyogi, global rate markets have had a dream run, particularly in last one year. This, in turn, could become a major source of volatility in case of mean reversal of yields.
Major central banks have already started highlighting the need for fiscal support. The strategy to move to fiscal expansion from fiscal austerity also gained traction in the G20 meeting held in China in July this year. An upward shift in the global yield curve will exert pressure on domestic yields and limit an incremental fall in yields in the coming days, said Niyogi.
On the flip side, the Bank of Japan’s (BoJ) policy is encouraging for India and could actually propel carry-trade in the near future.
BoJ has announced a long-term 10-year financing window at a fixed rate, expanding from the existing facility of a 1-year window. As it eliminates refinancing and interest rate risks, the new facility could encourage Japanese institutions to run leverage investments in other economies, offering higher rates.Soumyajit Niyogi, Associate Director - Credit & Market Research Group, India Ratings.