RBI pauses; rate cut cycle not over yet: Taimur Baig

The Reserve Bank of India (RBI) chose to leave the policy rates unchanged today but its statement did not ignore the ongoing economic situation, characterised by weak growth - particularly weak investment - and easing inflation (wholesale price index (WPI) momentum, measured on a seasonally-adjusted quarterly annualised rate, fell to 0.2 per cent in May).

RBI, however, expressed concerns about (i) the prices of some food items (cereals and vegetables) remaining elevated, (ii) the risk stemming from a weaker rupee's pass-through to inflation in the coming months, and (iii) the likely impact of adjustments in administered price increases, especially the likely rise in the government's minimum support price for foodgrain.

We, however, note that food inflation should not be a source of concern because a likely normal monsoon will help stabilise food prices and a weak domestic demand environment will prevent any meaningful pass-through from forex depreciation.

Also, since real interest rates have turned positive in WPI terms (+255 basis points or bps currently) and improved significantly even when measured in terms of consumer price index (CPI) inflation (which has come down to 9.3 per cent, from about 11 per cent in January), the case for further easing is amply clear.

The policy statement was marked by the inclusion of one phrase and the exclusion of another. No longer was the expression "limited space" used to describe the remaining room for policy easing. Instead, the statement suggested that "only a durable receding of inflation" would suffice to cut rates.

Fleshing out its guidance further, the central bank set out that continued weakness in growth, decline in inflation and improvement in the current account would open up room for further monetary policy easing.

We see all three developments continue to take hold in the coming months, as (i) growth indicators such as the purchasing managers' index, index of industrial production, auto sales, and trade data are lacklustre, (ii) inflation momentum is falling sharply and the outlook for commodity and food prices are weak, and (iii) both seasonality and the demand trend suggest near-term improvement in the trade balance.

Accordingly, we expect RBI to cut rates in July, September, and October (25 bps each).

Here are our relevant forecasts, which would pave the way for policy easing in our view: We see WPI and CPI inflation easing further to four per cent and seven per cent, respectively, by September, and the current account deficit narrowing considerably in the quarters ahead (notwithstanding today's trade data, which showed the trade deficit had increased to $20.1 billion in May).

We expect the January-March current account deficit to fall to 4.5 per cent of GDP, from a record 6.7 per cent in October-December.

Rupee worries are understandable, given global market volatility and the hefty need for financing of the current account. But inflation worries should be minimal and growth concerns heightened.

Taimur Baig,
Chief economist, Deutsche Bank India