RBI panel dims hope of a rate cut this year

Focus on inflation, higher CPI projection dampen bond market mood

The Urjit Patel committee’s estimate of a high level of retail inflation for at least one more year seems to have dimmed the hope of an interest rate cut by the Reserve Bank of India (RBI) in the near future.

In its report, made public on Tuesday, the committee, set up by RBI in September last year to review the monetary policy framework, had suggested that retail inflation replace wholesale inflation as the price anchor for determining the central bank’s monetary policy stance. It also recommended a road map for bringing down the rate of retail inflation, measured by the Consumer Price Index (CPI).

Since the committee expects the retail inflation rate to only come down to eight per cent over the next 12 months, market participants believe there is little possibility of a cut in the policy rate by RBI.

“The committee aims to cut the CPI-based inflation rate to eight per cent in 12 months and further to six per cent in 24 months; this implies elevated policy rates in 2014. The status quo appears to be the most likely scenario for the rest of 2014, unless the retail inflation rate falls below eight per cent,” says Samiran Chakraborty, managing director & regional head of research (South Asia), Standard Chartered Bank.

A month after touching a record high, the CPI-based inflation rate came down to a three-month low of 9.87 per cent in December, compared with 11.16 per cent a month ago. After raising the repo rate in successive monetary policy reviews — in September and October, by 25 bps each — the central bank had left the rate unchanged in its December review. A majority of market participants expect the central bank to maintain status quo in its third-quarter review on the coming Tuesday, as inflation has eased a little (though it is still above the Urjit Patel committee’s comfort zone).

The yield on 10-year benchmark government securities spiked on Wednesday. It surged six basis points to close at 8.61 per cent, compared with the previous close of 8.55 per cent, after touching a high of 8.68 per cent during the day.

Bankers say the measures suggested by the panel are hawkish on inflation and have not talked about growth.

In addition, comments like conducting open-market operations only for liquidity management, and not to manage yields, have also hit bond market participants’ confidence.

Since bringing down retail inflation from its current level is essential for a shift to the proposed framework of a monetary policy committee, the Urjit Patel committee also laid out a road map to contain it over two phases. It suggested that the retail inflation rate be brough down from the current 10 per cent level to eight per cent in a year, and then to six per cent over the next year, before containing it at the targeted level of four per cent.

“We see CPI-based inflation coming off towards 9-9.5 per vent by January and 7.3 per cent by March 2015, assuming normal rains and stable oil prices. This is not very different from the committee’s projected CPI-based inflation path over the next year. Against this backdrop, we continue to expect RBI to maintain a pause on January 28,” Bank of America Merrill Mynch said in a note to its clients.