RBI may ease by 25 bps, while maintaining a neutral stance

We expect the Reserve Bank of India (RBI) to cut the policy rate by 25 basis points (bps) on August 2, thereby pushing the repo rate down to 6 per cent. Since April, the Consumer Price Index (CPI) inflation has been surprising to the downside, and the June inflation print came at 1.5 per cent, which is 50 bps below the lower band of the RBI’s mandated target of maintaining inflation within the 2-6 per cent range. CPI-based inflation, excluding food and fuel, which has been a key concern for the Monetary Policy Committee members, also moderated below 4 per cent (3.9 per cent) in June — a record low. The CPI, excluding food, fuel and transport, came at 4.2 per cent, but this is also the lowest print in the new CPI series.

The central bank had revised its inflation forecast significantly downward in the last policy, and even then the June inflation print came below the lower bound of the new forecast range for first half of the fiscal year 2017-18. Recall that while discussing the inflation outlook, the June policy had stated: “If the configurations evident in April are sustained, then absent policy interventions, headline inflation is projected in the range of 2.0-3.5 per cent in the first half of the year, and 3.5-4.5 per cent in the second half.” We also take note of the phrase “absent policy interventions” but recognise that policy interventions need not only be monetary, and can also include government administrative policy intervention to stabilise food prices (in this case, the downward momentum of pulses inflation). However, given the lower-than-target June inflation print, we think the central bank will be able to justify a 25 bps rate cut comfortably in the August monetary policy.
 

We expect the RBI to maintain its neutral stance even while cutting the repo rate by 25 bps on August 2. Beyond the 25-bps likely rate cut, we think the RBI will remain in a wait-and-watch mode to decipher how the inflation trajectory evolves from July, when the impact of house rent allowance (HRA), the goods and services tax and higher food prices start getting reflected. 

With the US Federal Reserve getting ready to start its balance sheet reduction programme, and no other central bank in Asia looking to cut rates, we are not sure whether the RBI will want to signal a deeper rate cut cycle at this juncture. If growth and inflation continue to surprise to the downside even after incorporating the impact of HRA, and if global financial markets remain calm even with the Fed having started its balance sheet reduction programme, then there could be considerations for further rate cuts, but we think the RBI will not want to pre-commit to any directional bias at this stage. We expect the central bank to remain guided by evolving data points and market dynamics.

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The author is India chief economist, Deutsche Bank AG. The views expressed are personal.