Expert take: Central bank to stay on the sidelines

We expect the Reserve Bank of India (RBI) to keep policy rates unchanged in the coming monetary policy review. The chance of a further rate increase has receded with the moderation in consumer price index (CPI) and core CPI-based inflation momentum in August, but the softening in price pressure is insufficient to allow RBI to signal a dovish stance at this juncture.

Over the next few months, CPI-based inflation may moderate further toward 6.5-7.0 per cent, thanks to a favourable base effect. But from December onward, the base effect will turn negative, which would push headline inflation rate back to 7.5-8.0 per cent in the first quarter of 2015. This likely trajectory will be in line to meet RBI's target of 8 per cent CPI-based inflation by January 2015, but given the volatility in food prices, achieving 6 per cent headline CPI -based inflation rate by January 2016 will still be under question. Therefore, we see little scope of RBI cutting rates in the near term.

Over the medium term, RBI's monetary policy stance will be informed by the following considerations: RBI would want to establish positive real interest rate in the economy to encourage higher financial savings, which is critical to fund investment needs of the country.

According to our forecast, CPI-based inflation will average about 7.50 per cent in FY15 and 7.00 per cent in FY16. Assuming the central bank would want to maintain at least 0.50 per cent average positive real interest rate in the economy, the chances of rate cuts would only become feasible in the second half of 2015, in our view. We think RBI would have scope to cut the policy rate by 50 bps in the fourth quarter of 2015, but no more than that.

RBI could consider engineering an "effective easing" in market rates, by reducing the liquidity deficit in the money market, but this is unlikely to happen in a hurry, unless it gains some degree of comfort on the inflation and fiscal outlook.

Apart from inflation considerations, we think the policy framework would also be geared to maintain a neutral interest rate conducive to sustain a current account deficit in the 2-2.5 per cent of GDP range.

The author is India economist, Deutsche Bank