Further monetary easing on the cards

The sluggish investment scenario and need to ease supply constraints over the medium term had prompted the Reserve Bank of India (RBI) to "front-load" a rate cut in its second bi-monthly monetary policy review, in spite of the existing concerns regarding the inflation outlook. Subsequently, several such concerns have subsided to an extent, with a smaller-than-feared monsoon deficit, above-normal kharif planting, decline in commodity prices and relatively stable rupee.

In particular, the pass-through of lower global fuel prices to domestic retail prices and a favourable base effect for food inflation are likely to ease headline Consumer Price Index (CPI)-based inflation, the nominal anchor for monetary policy, well below five per cent in July-August 2015 from the nine-month high of 5.4 per cent in June 2015.

Moreover, ICRA Research expects retail inflation to undershoot the central bank's projection of six per cent in January 2016 and average 5.2-5.4 per cent in 2015, benefitting from the modest rise in minimum support prices for various crops and benign global commodity prices.

High frequency indicators continue to paint a mixed picture of economic growth, with healthy expansion in coal output, execution of road projects and cargo handled at major ports, juxtaposed with muted growth in electricity generation, railway freight and automobile sales, as well as contraction in exports.

In the context of RBI's view that the real interest rate, defined as the repo rate less "look forward" CPI, should be around 150-200 basis points, the prevailing growth-inflation dynamics have increased the likelihood of a further reduction of 25bps in the repo rate during the ongoing quarter.

Nevertheless, the timing of the next rate cut would need to balance the lingering uncertainty regarding the impact of the eventual kharif harvest on food prices with the likely lags in transmission. The commencement of the busy season for credit offtake in the third quarter is likely to tighten systemic liquidity and hamper the transmission process, which mildly sways the argument in favour of a repo rate cut in the upcoming monetary policy review.

The author is group CEO & MD, ICRA Ltd. The views expressed are personal