Some calm amidst the storm: Sajjid Chinoy

There is a central bank storm brewing globally. The ECB, Bank of Canada, Monetary Authority of Singapore, and now Royal Bank of Australia, have joined the Bank of Japan by easing earlier or more than expected. The motive is clear. No country wants to be left behind in the ongoing currency war.

Against this backdrop markets were still hoping the Reserve Bank of India (RBI) would surprise with another cut. After all, the dis-inflation has been much faster than expected. And shouldn't the RBI cut to depreciate the currency? (Imagine how the tables have turned on the rupee!)

Thankfully RBI stayed firmly on hold. The space for easing has clearly opened up, but uncertainties exist. How much of the disinflation is structural versus cyclical? No one is still quite sure. 70 per cent of the CPI disinflation in 2014 was on account of food, and 95 per cent of the latter is driven by cereals and vegetables. Yes, cereals' dis-inflation appears more durable on the back of lower MSPs. But its not clear if vegetable prices, for example, won't spike in the coming months. And then there's the fiscal uncertainty. Will fiscal targets be relaxed given the temptation to impart a growth stimulus? Given these uncertainties, RBI appropriately stayed on hold for now.

How much could they cut? Using recent economic evidence in India over the last decade - and the relationship between growth and "equilibrium" rates - we find that real rates need to be in the 1.5-2 per cent range so that any investment pick-up is financed domestically. RBI seems to be working with similar estimates. Therefore if inflation averages 5.5 per cent through this cycle, the space for another 25-50 basis points (bps) of cuts opens up. Lower inflation opens up proportionally more space. We therefore pencil in another 25 bps cut sometime after the Budget, and another 25 bps when there is more conviction of food dynamics later in the summer.

But why not a larger easing cycle to depreciate the rupee? Ironically, this could be counter-productive by attracting more debt flows looking to capture capital gains and more equity flows enthused by the loose monetary stance! The move to inflation targeting is predicated on the principle of having as many instruments as targets. RBI should use interest rates to fight inflation. And intervention and other macro-prudential pressures to fight rupee overvaluation. For Indian policymakers, establishing inflation credibility after years of mayhem must take precedence over any currency war!

Sajjid Chinoy
Chief India economist, JPMorgan