Rajan unlikely to surprise at his final policy meeting

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Will Reserve Bank of India (RBI) governor Raghuram Rajan, in line with his usual style, surprise the market by delivering a rate cut at his last policy meeting on August 9 (Tuesday)? We think this is unlikely, and expect the repo rate to be left unchanged at 6.5 per cent.

We acknowledge that some of the upside risks to inflation flagged by RBI at its previous policy meeting have subsided. Crude oil prices have reversed and are down 15 per cent since the June policy meeting. Moreover, good monsoon progress has been positive for sowing and water reservoir levels. A 40 per cent year-on-year increase in pulses sowing has raised hopes of deflation in pulses prices in H2. The softening of core-core inflation to an 11-month low is encouraging. Finally, long-awaited legislative approval of the GST Bill in the Rajya Sabha is an important step towards implementation of an important structural reform. GST is goods and services tax.

Despite these factors, we expect RBI to adopt a wait-and-watch stance. With CPI (consumer price index) inflation hovering close to the upper end of the agreed band (plus/minus two ppt around four per cent), a pre-emptive rate cut would be difficult to justify. Headline CPI inflation has been at 5.8 per cent for the past two months and we expect it to remain close to this level for the next couple of months. It is true that food inflation accounts for most of the upward pressure. But, since RBI looks primarily at headline CPI inflation in setting monetary policy, it is unlikely to overlook these elevated prints. More clarity on a sustainable decline in food prices and its positive impact on headline inflation would be needed to justify a rate cut. Scope for further easing is also limited given the RBI's CPI inflation targets of five per cent by January 2017 and four per cent by January 2018.

The door for future rate cuts is likely to be left open. We expect RBI to retain the phrase "accommodative stance" in its policy statement. While we currently do not expect RBI to reduce rates in FY17, a sharper-than-expected decline in food prices or lower-than-expected oil prices could create room for 25-50 bps of cuts.

The coming change of guard at RBI has raised expectations of deeper rate cuts. We disagree with this view. Such cuts would be a response to downside inflation surprises rather than a break from the current monetary policy stance, in our view. A well-defined institutional framework for inflation and the likely activation of the Monetary Policy Committee (MPC) by end-2016 are likely to limit the scope for rate cuts. Additionally, we expect policy makers to remain cautious as significant loosening of monetary and fiscal policy could adversely affect India's hard-earned macro economic stability of the past few years.

The writer is executive director and senior economist, India, Standard Chartered Bank