RBI dashes hopes of a rate cut for now

Rajan's deputy Khan cautions against early celebration of falling inflation, unhedged forex exposure

Less than a month ahead of the Reserve Bank of India's (RBI) fifth bi-monthly monetary policy review on December 2, Deputy Governor H R Khan on Friday cautioned industry and market players against "celebrating the falling retail inflation too early".

"Inflation still has a long way to go in terms of input costs, wage burden, food prices. There are structural issues," Khan said at an event organised by the Confederation of Indian Industry. "Rural areas are also seeing large inflation," Khan added.

Markets have been pricing in a repo rate cut from the RBI after consumer price-led inflation fell to 6.46 per cent in September, its lowest since the series was started in January 2012. Finance Minister Arun Jaitley and industry captains have also been asking the RBI in recent days to consider a rate cut.

The yield on the 10-year benchmark bond, which has been falling in the last five trading sessions, rose on Friday after Khan's statement. The yield on the 10-year benchmark bond had dropped to a 14-month low of 8.19 per cent on Wednesday. But on Friday the yield ended at 8.21 per cent.

On lower commodity prices, Khan said the current price of oil was being talked about as the "new normal", forgetting that there were risks like a collapse in oil-producing countries like Libya, geopolitical tensions or a drop in US production. Khan said when the global recovery was also tepid and there were many geopolitical issues, there was a need to be cautious. "We cannot be an outlier, particularly in terms of inflation, among BRIC countries," Khan said.

Khan referred to the fact that six years since the global financial crisis, countries like India continued to rely on accommodative policies of advanced countries. "The US quantitative easing has ended and we are still not sure about how the interest rate trajectory will play out. At the same time, Europe and Japan have announced quantitative easing. There are uneven prospects of growth in the rest of the world. People are struggling with tepid demand and impediments," he said.

According to Khan, growth sentiments are good, the savings-investment equilibrium is improving and the country can be cautiously optimistic on the domestic front. He pointed out that factors such as a stable government making attempts at structural reforms were encouraging, but at the same time tempered the expectations with possible scenarios that could dent the momentum.

Khan warned against "too much complacency" due to the stability of the rupee against the dollar. "People are now so comfortable with the rupee that there are issues of hedging. Too much of complacency is happening due to the stability syndrome," said Khan. In a speech last month, Khan had said the hedge ratio for external commercial borrowings (ECBs)/foreign currency convertible bonds (FCCBs) declined sharply from about 34 per cent in fiscal 2013-14 to 24 per cent during April-August 2014 with a very low ratio of about 15 per cent in July-August 2014. Khan said excess leverage, excessive unhedged currency exposure and not-well-thought-out outward foreign direct investment were the three things that added to vulnerability. Stating that he was "chastened" by the massive jump in foreign investments by Indian companies, Khan chided corporations for not doing enough research before taking their decisions, as many had to exit such investments in distress. "You've gone without proper research, due diligence and adequate planning. So, you now see large-scale disinvestment of such assets," Khan said.

Manish Wadhawan, MD and head of interest rates at HSBC India, said, "It is quite possible that we would see a gradual downward movement in yields. The underlying sentiment is still quite positive. The market will now look forward to the October CPI inflation numbers next week," he added. Others said December might be too early for a rate cut, but the RBI's stance would be dovish. "We are increasingly confident about our call for a RBI repo rate cut in February. While the December policy should turn more dovish, the Governor may want to await further clarity on the inflation peak-off," said Indranil Sen Gupta, India economist at Bank of America-Merrill Lynch in a note. Sen Gupta believes the RBI is set to achieve its inflation targets of 8 per cent for January 2015 and 6 per cent for January 2016. This is based on the assumption of normal rainfall.