Room for rate cut in second half of 2014: Taimur Baig

Every reason cited for policy tightening was present in December, but the central bank decided to wait and see at that juncture

Tuesday's move by the Reserve bank of India (RBI) was a curious one. After all, every reason cited as justification for policy tightening - sticky core inflation, upward risk to headline CPI (Consumer Price Index) in the forecasting horizon, elevated inflation expectations, risks from wages, etc - was present in December, but the central bank decided to wait and see at that juncture. Since then, headline inflation has eased sharply (it has continued to do so through this month, according to daily data on food and fuel), the central bank's survey has shown some easing of inflation expectations, growth indicators have weakened further, and commodity price risks have continued to fade.

We, therefore, feel Tuesday's rate rise makes sense only in the context of supporting last week's report on targeting inflation. The current global market volatility and the associated risks to the rupee might have played a role, too.

Looking ahead, while RBI's published projections depict disinflation in the coming months, core CPI inflation may not ease anytime soon. Even in the absence of food and fuel price pressure, the services sector and housing prices may continue rising. If this trend persists, along with an expected bottoming of growth in the next couple of quarters, RBI may prefer not to ease rates this year.

Still, given its forecast that policy easing could be entertained if disinflation turns out to be swift and sustainable, and since our projection path sees sub-six per cent headline inflation from mid-year, we think there is a 60-70 per cent chance of 25-basis point cuts in August and October. To maintain a positive one per cent real rate on a forward-looking basis (real rate=today's repo rate minus the CPI inflation forecast 12 months from now), RBI may need to raise rates again in 2015 with a view to achieving its inflation target.

Taimur Baig
Chief economist (Asia), Deutsche Bank