RBI delivers a jumbo surprise; more reasons for INR to underperform: Nomura

The policy outlook will depend on the macro outlook. We see downside risks to the RBI's GDP growth and CPI inflation outlooks, said Nomura, in a note.

Nomura on RBI rate cut: Policy repo rate was cut by 50bp to 5.50 per cent, against consensus and our expectations of a 25bp cut. The governor described this as a frontloaded rate cut, which was made possible by the durable alignment of inflation with the target.

 

The policy stance was changed to “neutral” from “accommodative”, another surprise, to signal that, with 100bp of cumulative cuts already delivered, “monetary policy is left with very limited space to support growth”.

 

Additionally, even though banking system liquidity is already in surplus, the RBI surprised by cutting the cash reserve ratio by 100bp to 3.00 per cent, which will be made effective in a staggered manner and will release ₹2.5 trillion in liquidity.

 

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On its macro forecasts, the RBI retained its GDP growth forecast at 6.5 per cent y-o-y in FY26, as expected, and lowered its CPI inflation forecast to 3.7 per cent (from 4.0 per cent), largely as expected, acknowledging that inflation will undershoot its 4 per cent target this year.

 

Today’s policy decision constitutes a major surprise. The RBI’s MPC had just changed its stance to “accommodative” at the April meeting, so a flip back to “neutral” soon suggests more nimble decision making.

 

The combination of a 50bp cut, a shift in stance to neutral and the CRR cut signals that the RBI’s MPC believes the existing space for policy easing has been largely exhausted, and they will be in a wait-and-watch stance now, with policy transmission the key objective. This suggests that, unless there are major economic surprises, the RBI will be on hold in August and beyond.  ALSO READ | How will RBI's policy decision impact market? Analysts prefer these stocks

 

However, the policy outlook will depend on the macro outlook. We see downside risks to the RBI’s GDP growth and CPI inflation outlooks. On our forecasts, GDP growth is likely to surprise lower at 6.2 per cent (RBI: 6.5 per cent), while CPI inflation is tracking even lower at 3.3 per cent (RBI has now revised to 3.7 per cent). Therefore, we do not view today’s action as the end of the easing cycle. We continue to see the terminal rates at 5.00 per cent, with a likely pause in August, followed by 25bp rate cut in each of October and December.

 

The RBI surprised with a 50bp rate cut and a 100bp CRR cut, which initially led to a weaker INR. However, with the signal from RBI that this move was frontloading and as the RBI also changed its monetary policy stance to “neutral”, this led spot USD/INR back down to be largely unchanged.

 

Given our economics team’s views of continued downside growth challenges ahead and further RBI rate cuts, we see limited support for INR from a macro perspective. Overall, we still expect INR to underperform, and today’s actions and the policy/macro outlook do not change this view.

 

We remain long EUR/INR (conviction level: 3/5), given the softer USD outlook as well as the recent, relatively hawkish surprise from the ECB (5 June ECB meeting). Locally, we believe the RBI will continue to accumulate USD, with the recent evidence from the April FX forward book and FX reserve developments.  ALSO READ | RBI's policy resets bond markets, signals deeper yield compression ahead

 

On liquidity, the RBI noted how it wants to provide sufficient system liquidity, given transmission has been slow. It surprised with a 100bp cut to the CRR rate, which will inject ₹2.6 trillion into the system in a staggered approach. Considering this staggered approach (effectively monthly starting from 6 September), the RBI is likely done for now on OMOs and other liquidity measures. We still expect more measures in H2 of the financial year, but further action seems unlikely in the near term.

 

On strategy, we maintain our positive stance on India rates. We increase our conviction level back to 4/5 on long 5y IGBs (6.75 29s, current 5.76 per cent), targeting a move down to 5.50 per cent (was 5.75 per cent). 

 

The CRR cut and the recent bond buyback further skews the SLR supply / demand equation in favour of lower yields, especially as the government also continues to switch short-dated paper for longer-dated. We expect the IGB curve to steepen.

 

(Disclaimer: The above article is excerpted from a Nomura report. Views are their own.)