We see additional 50 bps rate cut by Q1 FY16: Shubhada Rao

Q&A with Senior President & Chief Economist, YES Bank

Shubhada M Rao, Senior President & Chief Economist in an interview with Tulemino Antao shares her view on the surprise rate cut move by the RBI and trends going forward. Edited excerpts:

What is your take on the surprising rate cut by the central much ahead of the policy meet in early February?

While we had been expecting a 25 bps rate cut in the upcoming Feb-15 policy review, the timing was unanticipated. It has two important takeaways:

1.      The RBI stuck to its Dec-14 guidance of change in monetary policy stance “early next year, including outside the policy review cycle”. This enhances the credibility of the central bank

2.      The shift in the hitherto tight monetary policy stance suggests growing comfort on the inflation trajectory, government’s actions on curbing part of food inflation and its commitment towards adherence to fiscal deficit targets

The RBI has set fiscal consolidation for further lowering of interest rates. When do you forsee the next rate cut if any during the current fiscal?

We see additional 50 bps rate cut by Q1 FY16. In terms of timing, the cuts are likely to take place in Apr and Jun policy reviews. After today’s move, we don’t see the need for any policy action in the Feb policy review.

Do you think this rate cut is enough to revive growth?

A 25 bps rate cut is not enough to revive growth. However, we should note that with today’s rate cut, the RBI has signaled a decisive shift in its monetary policy stance. With trend rate of inflation likely to remain in the sub 6.0% range in the near to medium term, the RBI will have room for another 50 bps rate cut within the next six months. A gradual easing of interest rates in the economy will eventually provide support to economic growth.

How much do you think the falling crude oil price impact on inflation will help the economy and will it spur further rate cuts?

With India being a net importer, fall in global commodity prices, particularly crude oil will have a multifarious positive impact on the economy. A 10% sustained fall in crude oil prices normally results in 20-30 bps decline in headline CPI inflation while improving the fiscal health by 0.1% of GDP, ceteris paribus.

A soft commodity price regime acts as a positive supply shock for importing economies. This can potentially spur rate cuts if the price decline is believed to be durable in the medium term.

What could be the key factors local or global that the RBI may have to halt further reduction in interest rates going forward?

On the global front, sharp increase in financial markets volatility on the back of earlier than anticipated interest rate hikes by the Fed and the BoE could create pressure on rupee, thereby limiting the scope for aggressive monetary easing. On the domestic front, government’s inability to push forward supply side reforms and non-adhere to quality fiscal consolidation could be a dampener.

What trends do you see in the bond prices with the interest rate cycle softening?

Bond markets reacted positively to the unexpected timing of the rate cut with the 10Y g-sec yield trading around 7.68% levels, down 9 bps from yesterday’s close. Going forward, we expect 10Y g-sec yield to trade close to 7.35% levels before the end of FY16 with risks balanced on either side. While monetary policy normalization by the Fed and BoE could provide volatility to rates in mid 2015, persistent softness in commodity prices could provide downside risks to yields.