Anubhuti Sahay: More rate cuts seem likely

Of the three surprise decisions by the Monetary Policy Committee (MPC) meeting since Reserve Bank of India (RBI) Governor Urjit Patel assumed office in September, possibly the latest decision to change its stance from accommodative to neutral was the least unexpected. This was announced even as RBI expects FY18 inflation to probably average about 4.5 per cent (assumed by looking at their H1FY18 and H2FY18 consumer price index or CPI forecasts). With its real rate preference defined at about 125 basis points (bps), ideally this indicated room for another 25-50 bp cut.

So, the key question is has the rate-cutting cycle come to an end in India. We think so. We note three points in this regard.

First, by switching to neutral from accommodative, RBI has retained the flexibility to move repo rate either ways depending upon the evolving macroeconomic situation. Thus, future rate cuts are still possible.

Second, even before this policy meeting, there was a wide market consensus that interest rate cut cycle was close to an end. The debate on the remaining rate cut was between 25-50 bps. Given our own average FY18 CPI-based inflation forecast of 4.6 per cent, we did see a room for a 50-bp rate split equally between February and April policy meeting before the policy announcement.

Third, usually RBI changes stance (accommodative/hawkish from neutral) before they act on repo rate in one direction on the other. Looking at the previous policy statements since 2004, we note no instance where RBI has reduced rates while maintaining a neutral stance (barring black swan events like the global financial crisis).

While there can be always a first time (i.e. a rate cut with neutral liquidity) we think adopting such a move say in the next six months could raise its own set of challenges for RBI. To us, the hastened pace with which RBI changed its stance to neutral indicates that RBI is concerned about external developments viz. potential hikes from the Federal Reserve, rising US and global yields. If this is the case, cutting rates later in the year can become even more challenging, in our view. We expect the Federal Reserve to hike rates five times between now and 2018.

 Also, while we expect CPI to remain four per cent till June 2017, unless there are significant downside inflation surprises, achieving four per cent by March 2018 looks difficult. Thus rate cuts look likely to us.