Reserve Bank of India may cut rates even more than expected this year

January 20, 2016

Reserve Bank of India (RBI) Governor Raghuram Rajan attends a news conference in Mumbai, India, December 1, 2015. REUTERS/Shailesh Andrade - RTX1WLY7

The Reserve Bank of India is widely expected to cut interest rates just once in 2016, as most analysts see retail inflation rising slightly above the central bank’s target, but there is a decent chance it could cut more aggressively, as it did last year.

Indian inflation has fallen rapidly from double-digits to less than 6 percent over the past two years, as the slump in global commodity prices fueled disinflationary pressures and allowed the RBI to cut rates by 125 basis points to 6.75 percent in 2015.

Ashutosh Dattar at IIFL is only one of two strategists polled by Reuters in the past week who expect the RBI to chop rates by a larger amount than the median predicts. Dattar was the only analyst who accurately predicted the RBI would cut rates by as much as 50 basis points in September, a move which took markets by surprise.

He says RBI Governor Rajan will cut rates once in April and then again in June, each time by 25 basis points.

In April is when they (RBI) will have some sense of what the monsoon will look like, the budget will be out of the way so they will have clarity on fiscal targets.

They want inflation to come down to 5 percent by January of next year and there is a downside to that. Assuming a normal monsoon this year, assuming that fiscal deficit, if the government sticks with the consolidation target, and given commodity prices — especially where oil has gone in the last few weeks — it makes me more confident inflation will undershoot the RBI’s trajectory. They could do more than 50 basis points (of) rate cuts given where commodity prices are.

Several major banks, such as Goldman Sachs, Morgan Stanley, Citi and BofAML, say oil prices will fall much lower than the current $29 per barrel. Not too long ago, most analysts said commodity prices would rebound and inflation, through base effects, would rise as a result.

Indian inflation could once again be dragged lower by the slump in fuel prices.

Oil v Indian inflation

India’s economic growth rate has also been of some concern to analysts.

Despite his expectations for a pick-up in growth, Dattar said demand was ‘weak’. He pinned the reason for expected improvement on agriculture and said outside of that industry, which makes up about 13 percent of GDP, there was little reason to be optimistic.

Dattar added that the global economic slowdown had also been affecting India “through weak exports” and ‘might require policy be more “accommodative”.

He also played down suggestions that reforms, particularly the goods and service tax that would transform India into a single market, would add anything like the 2 percentage points to an already-solid, but relatively stable 7.4 percent rate at last measure.

One thing arguing against RBI rate cuts is that the U.S. Federal Reserve has begun to “normalise” its policy. But the Fed could be forced to price in a slower rate hike trajectory for this year than its own projections for four more hikes. That could leave the RBI with more room to cut.

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