Doves Ascendant in India on Brexit After Hounding Rajan on Rates

  • One-year interest-rate swaps fell to lowest since 2010 Tuesday
  • RBI ‘likely to turn more dovish’ in coming months: Nomura

The debate over India’s room to cut interest rates, which saw the central bank governor pilloried by populist politicians, is swinging in favor of the doves after Britain’s vote to exit the European Union.

Nomura Holdings Inc., which wasn’t expecting any easing from the Reserve Bank of India, now forecasts a 25-basis point reduction by end-2016. Credit Agricole CIB is reviewing its call for just one cut in the second quarter of 2017. The cost to lock in rates for one year in the swap market sank to 6.53 percent on Tuesday, the lowest since 2010, nearing the RBI’s 6.50 percent benchmark, amid speculation Governor Raghuram Rajan’s successor will heed to calls from some lawmakers amid Brexit-inspired global market chaos.

“The central bank is likely to turn more dovish in the coming months, given risks to economic growth as Brexit threatens to weigh on exports,” said Vivek Rajpal, an interest-rate strategist at Nomura in Singapore. “Proactive liquidity management and monetary easing expectations should act as a counter-force to some of the uncertainties.”

India is already battling an export slump, with overseas shipments having contracted for 18 straight months. While the U.K.’s share in exports is just about 3.5 percent, the rest of the EU accounts for about 13.5 percent, according to Japan’s biggest brokerage. Analysts at Nomura reduced their 2016 growth forecast to 7.3 percent from 7.6 percent, according to a June 24 report.

Subramanian Swamy, a member of Prime Minister Narendra Modi’s ruling party, publicly criticized Rajan for keeping rates unnecessarily high, even as the RBI chief pared the repurchase rate five times since early 2015 to a five-year low in April. Optimism that strong monsoon rains will boost food production and the need to cushion growth in Asia’s third-largest economy from Brexit shocks are once-again fueling easing bets.

Yes Bank Ltd. sees some chance of a 25 basis point cut prior to its estimate for a move in the October-December quarter. Rajan has said he will step down when his term ends in early September. No replacement has been named.

‘Adverse Impact’

Brexit “is likely have an adverse impact on India’s growth through trade and financial channels,” though much less than more open economies, Morgan Stanley economists including Chetan Ahya in Hong Kong wrote in a June 26 report. The central bank can respond with liquidity-enhancing tools, exchange-rate intervention and rate cuts, they wrote.

Morgan Stanley expects another 50 basis points of easing as it sees inflation decelerating to 4.5 percent by March 2017, below the RBI’s target of 5 percent. Consumer prices rose 5.76 percent in May from a year earlier, the fastest pace in 21 months.

Prime Minister Narendra Modi’s cabinet approved an increase in salaries for civil servants, a government official told reporters on Wednesday. Higher salaries, however, also stand to boost consumption that’s been the key driver of the world’s fastest-growing big economy.

The rupee is Asia’s second worst-performing currency this year, having fallen 2.3 percent to 67.6850 a dollar in Mumbai on Wednesday. It slumped to as low as 68.2150 on Friday, near a record 68.845 per dollar hit in 2013, as Brexit roiled global markets.

Improved Liquidity

Investors are drawing comfort from the forecast for the highest monsoon rainfall in 22 years. The June-September seasonal showers can boost farm output and curb consumer food prices, which rose 7.55 percent in May.

A good monsoon can act as a trigger for a “more aggressive” easing, said Rajeev Radhakrishnan, Mumbai-based head of fixed income at SBI Funds Management Pvt., which oversees 1.07 trillion rupees ($15.8 billion) of assets. Rainfall so far has been 13 percent below normal.

One-year swaps have fallen 13 basis points this month to 6.55 percent, partly helped by RBI measures to boost cash supply in the financial system. The yield on the benchmark 10-year bonds has dropped three basis points in June to 7.44 percent, its lowest close in almost seven weeks.

“The market is expecting monetary policy to be more accommodative as Brexit clouds the global growth outlook,” said Himanshu Malik, a strategist at HSBC Holdings Plc in Hong Kong. The decline in swaps is a “reflection of both increased expectations of further monetary easing and improving liquidity conditions,” he said.

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