5 key expectations from Raghuram Rajan's last monetary policy

Here is a snapshot of what the markets expect from the RBI's policy review on Tuesday

The Reserve Bank of India (RBI) will announce the Third bi-monthly Monetary Policy for 2016-17 on Tuesday. This will be the last policy by the current RBI Governor, Raghuram Rajan, whose term ends in early September.

Also Read: Central Bank likely to maintain status quo on Tuesday

The policy will be presented in the backdrop of rising inflation. Consumer price inflation rose to 5.7% in Q2 versus 5.3% in the first quarter of CY16, higher than the central bank’s target of 5.1%. 

“Markets are likely to look beyond the central bank’s decision to keep rates on hold on Tuesday, instead tapping into Governor Rajan’s commentary. While there is little clarity on who the next Governor will be or the policy committee members (beyond speculation) are, expectations for a dovish successor have spurred markets in recent weeks, especially the bonds space,” says a recent note from DBS.

Here are 5 key expectations from the RBI’s Monetary Policy review on Tuesday excerpted from a recent HSBC report:

 

Status quo on rates: Monsoon / Rains, HSBC says, will be one of the key determinants of how the interest rate trajectory will pan out going ahead. If rains weaken over the rest of August, reservoir levels will not be high enough to support a fall in food prices. 

“As such, it is best to be on a wait-and-watch-mode for now. Given the rise in CPI inflation over the last few months, we expect the RBI to be on hold in the upcoming 9 August policy meeting,” HSBC says.

Continue maintaining ‘accommodative’ stance: Given the possibility of food prices softening over the next few months and oil prices remaining low, HSBC expects the RBI to continue maintaining an 'accommodative stance’.

“We do not expect changes in the inflation or growth forecasts at this point, although the central bank could highlight more balanced risks on prices rather than 'upside risks', as it had done in the previous policy meeting (when oil prices were on the rise),” it says. 

Five-year inflation target: The government recently announced an inflation target of 4% (plus/minus 2%) for the next five years (until 31 March 2021). In the policy review on Tuesday, analysts at HSBC expect the RBI to discuss the challenges of reaching the 4% mid-point of the target, particularly the reforms required from the government's end. In the past the RBI has outlined the need for reforms in food distribution, health and education and infrastructure investment.

Liquidity and monetary transmission: Given that in the past banks had complained about tight liquidity conditions as a deterrent to monetary transmission, the RBI is likely to re-iterate the importance of banks cutting deposit and lending rates to support India's growth recovery, says the report. 

Policy rate outlook: Beyond the August meeting, HSBC expects the RBI to cut the policy repo rate by 25 basis points (bps) in the fourth quarter (4Q), if rains remain strong. 

"This final cut is in line with the RBI's preferred real rate range of 1.5 - 2%. With this, the RBI would have delivered 175 bps in rate cuts and we do not see space for more, given most drivers of disinflation have played out their parts over the last 18 months and only hard work via structural reforms can lower inflation from here on," HSBC says.