RBI may hold rates in 2016, says Nomura report

It expects underlying core CPI inflation to remain above RBI's 5% target in March 2017

The Reserve Bank of India (RBI) is likely to keep the repo rate unchanged in 2016 as consumer price index (CPI)-based inflation may remain above its target of five per cent by March 2017, says a report. “With inflation expectations still elevated, we expect RBI to keep policy rates on hold in 2016 and instead focus on greater transmission,” Nomura said in the report.

As disinflationary forces stabilise — oil, rural wages, negative output gap, minimum support price (MSP) — the report expects underlying core retail inflation to remain above RBI’s five per cent target in March 2017.

Headline retail inflation should rise above six per cent due to higher housing allowances, it said.

In the fifth bi-monthly monetary policy review last week, RBI kept the repo rate unchanged at 6.75 per cent.

"RBI will use the space for further accommodation, when available, while keeping the economy anchored to the projected disinflation path that should take inflation down to 5 per cent by March 2017," it had said in the policy statement.

According to a report by Bank of America Merrill Lynch, RBI will go for a 25-basis point cut at its February policy meet.

Nomura further said it expects GDP growth to rise to 7.8 per cent y-o-y in 2016, from 7.3 per cent in 2015, aided by private and government consumption and a slight pick-up in investments.

"We estimate India's potential growth at around 8 per cent, which implies that the output gap will gradually narrow over the course of 2016, before closing fully by the first quarter of 2017," the report said.

It, however, sees risks from implementation of the 7th Pay Commission recommendations, which it said would mean higher inflation (transitory) and fiscal challenges.

"We expect quantity and quality of fiscal consolidation to suffer," the report added.

Nomura expects a slight slippage in the fiscal deficit to 3.6 per cent of GDP in 2016-17 as against the target of 3.5 per cent and a smaller rise in government-funded capital expenditure.

With higher domestic growth and real effective exchange rate appreciation, the report expects marginal current account deficit widening to 1.3 per cent of GDP in 2016, from 0.9 per cent in 2015.