The odds of a rate cut over the next two quarters appear to be high as the new monetary policy committee (MPC) which will now decide on interest rates meets for the first time on Monday.
The policy decision on October 4 — the first of Urjit Patel as Governor — will follow an intense discussion among the six members of the MPC comprising three economists (Chetan Ghate, Pami Dua and RH Dholakia), two senior RBI officials (Deputy Governor R Gandhi and Executive Director Michael Patra) and RBI Governor Urjit Patel, starting from Monday.
Analysts say the outcome will be the same whether the decision is made by the governor alone, as had been the practice before, or by the MPC. Going by its tradition and the fact that RBI uses a common pool of data and reports, the three RBI members of the MPC are expected to vote as a bloc, they say. In case there is a tie, the RBI Governor has the casting vote. This means that even if three government nominees seek a rate cut and the RBI nominees, the RBI Governor’s decision will prevail.
“The RBI has two objectives — to reach its 5 per cent inflation target in early 2017 and keep real rates at the 1.5-2 per cent range. Marrying the two would open up space for easing by 50 bps. We expect a 25 bps rate cut at both the December and February policy meetings,” said Pranjul Bhandari, chief India economist, HSBC. “I expect the RBI to hold the rate in the October review and go for a reduction in December as inflation is expected to be benign,” said Rajnish Kumar, MD, State Bank of India.
Considering the expected trajectory of inflation and other data, a rate cut in the fourth quarter is a foregone eventuality with the debate largely centred over the timing of the move. Though Patel was earlier known as a hawk, recent reports about his interaction with economists suggest that inflation is unlikely to harden under the GST regime and that growth was part of the MPC’s mandate. “It remains to be seen if the officials prefer to mark the first meeting under the new Governor/ MPC with a rate cut. Or prefer to acknowledge the encouraging inflationary trend and lay the ground for a move in December,” said Radhika Rao, economist, DBS Bank.
In August, consumer inflation corrected sharply to 5.1 per cent from July’s 6.1 per cent with sub-5 per cent level likely in rest of this quarter and the fourth quarter. “With the US Fed leaving rates on hold earlier in the week, odds of a frontloaded rate cut in October have risen. Markets have largely priced in one measured cut in Q4, with downside surprises in inflation likely to allow the MPC to ease rates further. Global dynamics, steady core inflationary pressures and need to maintain real rates will pose hurdles for an aggressive easing cycle,” Rao said.
A section of the market expects the rate cut to be announced on October 4. “We foresee a 25 bps cut in repo rate in the policy review on October 4. Recall, that the RBI maintained status quo in August, citing rise in inflation and upside risks to 5 per cent projection of March 2017. Since then, headline inflation has fallen sharply and more importantly, further disinflation is in store over next few months as pulses prices deflate. Thus, headline CPI will likely slip towards 4 per cent levels in the interim before rebounding modestly, though it would likely undershoot the RBI’s target of 5 per cent by end FY17,” said an analyst with Edelweiss Securities.
There’s every possibility for the RBI to wait till December for further confirmation of disinflation trend, but the market view is that MPC will be uncomfortable cutting rates very close to a potential US Fed rate hike. According to Bhandari, there are some good reasons why a rate cut could materialise in the upcoming October 4 meeting. The recent fall in food prices has been sharper than expected, and cutting earlier keeps the RBI a safe distance away from possible Fed hikes. “Yet, our base case is for a rate cut in December. This is because, by December, two new inflation prints which are expected to be well below 5 per cent will be available.
Moreover, given that the RBI was highlighting upside risks until its last meeting, it may prefer to move in steps, i.e. change the outlook on inflation now and cut rates in December,” she said.
Furthermore, to get more bang-for-the-buck for monetary transmission, the RBI may want to get through the period of foreign currency non-resident (FCNR) deposit outflows before it cuts more. “We expect the commentary on the October meeting to be dovish, with the RBI highlighting downside risks to its inflation forecasts (if not actually lowering the forecast). Either approach is likely to be accompanied by a recommitment to its accommodative stance, with the central bank stating once again that it remains data dependent,” HSBC said.
The RBI last cut the repo rate by 25 bps to 6.50 per cent in the April 2016 review. Since January 2014, Raghuram Rajan, who left the office on September 4, had cut rates by 150 bps. However, banks have passed on only around 80 basis points to the customers.