Indian central bank to hold its horses while others bolt

February 15, 2016

A member of the Sikh Nihang warrior sect, mounts two racing horses during the annual "Rural Olympics" on February 22 in the village of Kilaraipur in India's northern state of Punjab. The three-day festival, in its 55th year, began on February 21. - RTXHNV1

Financial markets and borrowers rooting for the Reserve Bank of India to ease policy this year could be in for a disappointment – in stark contrast to 2015 when it lopped 125 basis points off the repo rate.

Should they hold steady, it would put India increasingly out of step in a world where most central banks appear to be racing to ease policy.

That’s not yet the consensus though.

In the latest Reuters poll, a clear majority predicted RBI Governor Raghuram Rajan would trim rates once this year – from 6.75 percent to 6.50 percent.

But the risk is if inflation, at 5.7 percent in January and above the RBI’s target of 5 percent by March 2017, continues to rise as it has over the past six months.

Economists at Capital Economics wrote:

We think that the window for further easing following the cumulative 125bp of rate cuts since January 2015 has now shut.

Capital Economics is one among only 8 of 33 economists in the latest Reuters survey who predict the RBI will hold policy steady this year.

Rajan’s battle to keep inflation low could also be undermined by the government, which may overshoot its deficit target when it announces its budget for the next fiscal year on Feb. 29.

Against all that, the minority view of no rate cuts this year may well morph into the consensus.

RBI repo rate vs polls

Indian consumers have historically had to deal with sticky prices, even though retail inflation has nearly halved since late 2013, and could continue to do so.

In contrast, inflation in many developed economies has cooled drastically in the past year resulting in central banks from Asia to Europe easing policy and adding stimulus. Some economies, such as the euro zone, are even faced the risk of deflation.

Yet, there are many reasons why inflation in India might not be on a downward course and that is, perhaps, why expectations of further rate cuts may have become out of sync with reality.

India CPI vs polls

  • The Indian government has gradually increased excise duties on fuel, even as global oil prices have collapsed over 70 percent since mid-2014, and is set to bump up salaries of public sector employees by a significant amount in its budget
  • A weaker Indian rupee, owing to the global capital flight to safer assets, has also pushed up import costs
  • A much hotter January than usual could hurt harvest crops like wheat, a staple ingredient in the average Indian’s kitchen, and push up food inflation

Recent comments from government officials appear to suggest they are leaning towards relaxing the central bank’s inflation targets although Rajan has repeatedly stressed the importance of standing by those goals.

Indeed, even though there are doubts over the accuracy of India’s growth data, the economy is still growing at a relatively healthy pace compared with both emerging market peers and developed nations.

India’s central bank may have been among the first to kick off a round of global policy easing last year, a strategy still being played by its major counterparts – but the RBI might just hold its cards this year.

– Additional reporting by Sumanta Dey

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