Photographer: Adeel Halim/Bloomberg

India Decision-Day Guide: RBI May Tone Down Rhetoric on Rates

  • 48 of 50 economists surveyed see no change in policy rate
  • RBI may lower inflation forecasts, ease its hawkish bias

India’s central bank is expected to keep policy interest rates unchanged, but may lower inflation forecasts and dial back its hawkish rhetoric on price pressures, paving the way for a possible reduction later in the year.

All bar two of the 50 economists surveyed by Bloomberg News expect the Reserve Bank of India to keep the repurchase rate at 6.25 percent on Wednesday. Two economists expect a cut in the repo as well as the reverse repo rate as inflationary pressures cool and growth drops to it slowest pace in two years. None expect any change in the cash reserve ratio.

If Governor Urjit Patel cuts rates, he will take the repo rate to its lowest in over six years and will continue a string of surprises that he and the monetary policy committee have sprung on investors since taking over in September last year.

In April, the monetary policy committee raised the reverse repo rate in a bid to tighten liquidity conditions after having shifted to a neutral stance in February, ending a two-year easing cycle. In December, when almost everyone was expecting the central bank to cut rates after an unprecedented cash ban hurt activity, Patel held rates. And in October, while chairing his first MPC meeting, Patel cut interest rates even though a majority were expecting him to stand pat.

"Growth and investment need to improve -- these are indicators which are available," Arun Jaitley, finance minister, said in a statement to CNBC TV earlier this week. "Any finance minister under these circumstances would like a rate cut, the private sector would like a rate cut. But then when you entrusted it with the MPC, I would rather wait for their decision."

The monetary authority will announce its decision at 2:30 p.m. in Mumbai followed by a press conference 15 minutes later.

Slowing Inflation

Patel had said in April that although headline inflation may come under target in the near term, the outlook for consumer prices called for "close vigilance". Other monetary policy members also remained concerned about inflation, minutes from the meeting showed in April.

Over the medium term, the central bank aims to keep inflation around 4 percent and has said that core inflation -- which strips out volatile food and fuel costs -- has been sticky. According to economists at ICICI Bank, India’s largest private sector bank by assets, core CPI inflation rose 4.5 percent in April from a year earlier, which was slightly lower than the 4.8 percent rise seen in the year to March 2017.

Headline retail prices have also slowed. Consumer prices rose 2.99 percent in April from a year earlier, down from 3.89 percent in March and below the 4.5 percent inflation rate the RBI forecast for April to September, dragged down by lower food prices.

A 5.5 percent rise in the rupee this year is also driving down the cost of imports and keeping inflationary expectations anchored. All in all, inflation has consistently undershot RBI forecasts, leading to speculation that the central bank may lower rates in coming months if price pressures soften further.

"With inflation expected to undershoot forecasts, we believe the space for modest easing is opening up later in the year," JP Morgan Chase &Co. economists Sajjid Chinoy and Toshi Jain wrote in a note. "We have penciled in a 25 bps cut later in the year, perhaps as early as the August review."

Growth Pangs

The drop in inflation comes at a time when growth is slowing as an unprecedented cash ban imposed by Prime Minister Narendra Modi bites. The latest data shows the economy has been slowing even before the note ban, bolstering a view that it might need a dose of monetary stimulus to help revive activity.

Read more: Slowest Growth in Two Years Confronts Hawkish India Central Bank

Gross domestic product expanded by 6.1 percent in the January to March quarter, the slowest in two years and undershooting economists forecasts in a Bloomberg survey by a full percentage point. The economy grew 7.1 percent for the fiscal year ended in March, down from 8 percent in the previous year.

A private sector survey released last week also showed the factory sector slowing in May from a month earlier. Looming over the economy is also the introduction of a national goods and services tax, scheduled for July 1, which could cause short-term disruption to activity.

Standard Chartered Plc’s economists Anubhuti Sahay and Kanika Pasricha wrote in a note that they expect economic activity to be subdued and have pencilled only a marginal improvement in GDP growth to 7.3 percent in the financial year 2018 from 7.1 percent in the previous year.

Nevertheless, the RBI is expected to sound optimistic and would expect growth to pick up in the rest of the year. A normal monsoon is poised to boost rural incomes while increased government spending, and higher allowances for workers in the public sector may bolster activity and consumption in the $2 trillion economy.

Zombie Debt

While India’s is still expected to remain one of the fastest growing major economies in the world, there is a significant risk it needs to overcome: a mountain of bad debt at the nation’s banks, especially in state-run banks. Soured loans have contributed to a $191 billion pile of zombie debt, or nearly 8 percent of GDP and cast the future of some lenders in doubt and curbed investment by businesses.

Read more: Why India’s Zombie Debt Imperils Modi’s Plans: QuickTake Q&A

The quantity of new loans that over-leveraged businesses are willing to take and that under-provisioned banks are willing to give, is slowing, dragging credit growth to its lowest in atleast 25 years. Investment by private companies actually started to shrink in the year through March and will, by the government’s estimate, contract by more than 7 percent this financial year.

The tardy demand for credit along with a deluge in bank deposits after the cash ban has left the RBI grappling with excess funds.

"In our view, this is an opportune time to keep the rate discussions on the sidelines and focus more on pressing issues such as non-performing loans resolution in public sector banks and the surplus liquidity in the banking system," said Kaushik Das, chief economist at Deutsche Bank.

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