(Bloomberg) -- A year ago, India had Asia’s fastest growth and inflation. Then Prime Minister Narendra Modi took away most of its money and both indicators slowed, bolstering expectations the central bank will cut borrowing costs for a final time this cycle as pressure mounts for a stimulus.
The Reserve Bank of India’s six-member monetary policy committee will lower the repurchase rate to 6 percent from 6.25 percent, according to 40 of 56 economists in a Bloomberg survey before Wednesday’s announcement. The rest see no change. The reduction would bring the benchmark rate to the lowest since 2010 and mark a U-turn from just six months ago, when Governor Urjit Patel jettisoned an accommodative bias for a neutral policy setting.
Consensus has built for a cut because it’s seen as Patel’s last chance through 2018 to spur the economy before the U.S. Federal Reserve reduces its balance sheet, forcing emerging markets to keep pace. India’s record-low inflation is also flattered by last year’s prices and low global food costs, which are expected to reverse in coming months.
“Given that the inflation reading has further surprised with a sub-2 percent print, we find some room for RBI to be accommodative," said Madhavi Arora, an economist at Kotak Mahindra Bank Ltd. in Mumbai, who predicts a reduction on Wednesday. "However, we reckon that the room for further monetary accommodation remains limited."
Consumer prices rose 1.5 percent in June, below the RBI’s April-September forecast range of 2 percent to 3.5 percent. It will end 2017 around the medium-term target of 4 percent, according to the median estimate in a Bloomberg survey. Economists also reduced their growth projections for the previous quarter as loan-growth hovers near a record low and job losses mount after Modi last year surprisingly scrapped 86 percent of currency in circulation.
Earlier this month, Modi’s top economic adviser Arvind Subramanian said India was undergoing a "paradigm shift" in prices and called upon policy makers to reflect "very, very, carefully" upon June’s unprecedented inflation and soft industrial output. There were also signs of dissent within the MPC, with one member breaking ranks for the first time to urge a sharp 50 basis point cut.
The country’s largest lender, State Bank of India, reduced deposit rates on Monday for most of its customers citing a slowdown in inflation and consequent rise in inflation-adjusted funding costs. It said it took the step to avoid raising costs for borrowers.
Baking in a Cut
Besides angering the government, a hold on rates this week would risk roiling the stock and bond markets that have pretty much baked in a 25 basis point reduction. The benchmark 10-year government bond yield has fallen to 6.45 percent this month from 6.51 percent -- best performance in Asia -- while India’s main stock index has risen nearly 4.5 percent during the same period.
However, a cut in interest rates by the RBI could pressure the rupee that has strengthened some 6 percent this year by offering investors who borrow in dollars the highest carry returns in Asia.
Tuuli McCully, Singapore-based head of Asia-Pacific Economics at Bank of Nova Scotia, says majority of the MPC is committed to an inflation-targeting monetary framework and are strong advocates of central bank independence.
“Therefore, they will likely see through temporary dips in headline inflation and instead focus on core inflation that has not eased in tandem with the headline rate," McCully said. "They are also likely to refrain from voting according to the government’s preference of looser monetary policy."
What deepens the quandry is that while the markets are betting on a cut, Patel’s team has been mopping up excess funds in the banking system, effectively tightening policy to ensure it doesn’t fuel inflation.
The RBI withdrew 200 billion rupees on July 6 and July 20 through open-market operations and announced more for August. It has also been using regular tools to drain funds and move to neutral liquidity from a surplus.
“The RBI should cut rates by at least 50 basis points if they want to help genuine borrowers but the probability of that happening has significantly reduced," said Rupa Rege Nitsure, chief economist at L&T Finance Holdings Ltd.
"If they cut rates after this, as a monetary economist, it does not make any sense to me. As things stand, the RBI’s reasons for maintaining their neutral stance remain unchanged."