Bank of America-Merill Lynch sees RBI cutting rates in 2015

The Reserve Bank of India (RBI) is expected to cut rates by 75-100 basis points starting early 2015, Bank of America-Merrill Lynch (BofA-ML) said in a report Thursday.

"With RBI Governor Raghuram Rajan recouping foreign exchange reserves, we see the RBI cutting policy rates even if Federal Reserve (US) chair Janet Yellen hikes from September 2015," the bank said.

The bank cites three reasons for the report's projections - rate differential, foreign exchange reserves and cooling of imported inflation.

On rate differential, BofA-ML said: "The India versus US rate differential is already at 800 basis points, far higher than the average 460 basis points since January 2003."

The bank sees the RBI cutting policy rates by 75-100 basis points in 2015, but adds: "The first cut will likely be pushed to February from our base case December."

The second factor is that foreign exchange reserves are key to rupee stability.

"High import cover allowed for a sustainable appreciation of the rupee during August 2006 and April 2008 although the rate differential on average was a mere 180 basis points. Rising rate differentials, even at 805 basis points on average, could not prevent depreciation during July 2011 and September 2013 as the import cover halved to 7 months," the bank said.

The BofA-ML report added that high foreign exchange reserves hold key for rupee stability, more than the US versus India rate differentials.

Thirdly, the bank feels that the US Federal Reserve's tightening will contain imported inflation by stabilising commodity prices.

"Fed tightening will itself likely contain 'imported' inflation by stabilizing commodity prices. Assuming normal rains, stable oil prices and a stable rupee, we expect CPI (consumer price index) inflation to come off to 6 percent levels by January 2016 in line with the RBI's targets," the report said.