Run-up to monetary policy review: Rate cuts likely to be front-loaded

An inter-meeting rate cut by the Reserve Bank of India (RBI) in January has increased the interest around the February monetary policy review. We think it is possible for RBI to cut rates again by 25bps in February to ensure calibrated monetary easing. Even after the base effect-driven volatility is over, inflation prints have been better than expected.

The benign global commodity price environment continues, leading to a sharp decline in household inflation expectations. Without any unexpected supply side shocks consumer price index (CPI)-based inflation is likely to stay below RBI's January 2016 target of six per cent for most of 2015. This will provide a window to RBI to change its monetary policy stance and deliver multiple rate cuts.

How many rate cuts can we expect? In our view, in the early part of this rate easing cycle, we can see 75 bps of a front-loaded cut in rates, spread over January, February and April.

This will take the real policy rate to about 150bps, calculated on the basis of our projection of average CPI of 5.8 per cent in FY16. Given the stage of India's economic recovery and taking into account historical trends, a 150bps real policy rate could be considered appropriate.

The extent of a rate cut could be higher if the global deflationary trend (particularly with respect to energy prices) continues for the rest of the year.

RBI's monetary policy stance should also take into account the overvaluation of the exchange rate. This is partially neutralising the expansionary effects of the fall in interest rates.

There is a risk that if the fiscal consolidation process is not in line with expectations, RBI might have to tone down its policy easing stance. The January statement appears to indicate that RBI is reassured of the government's commitment to adhere to the fiscal path. If RBI wants to have a confirmation of this from budget documents, in the February policy it might indicate the possibility of another inter-meeting rate cut. However, too many inter-meeting decisions could dilute the importance of scheduled monetary policy announcements.

The author is managing director, regional head of research, South Asia Global Research, Standard Chartered Bank