India Decision-Day Guide: Inflation Dip Gives Window to Cut

Updated on
  • 41 of 57 economists expect a 25 basis point rate cut
  • Focus on whether more policymakers join the dovish camp

Sonal Varma, Nomura's chief India economist, discusses the outlook for Reserve Bank of India policy with Bloomberg's Betty Liu, Kathleen Hays and Yvonne Man on 'Bloomberg Daybreak: Asia.' (Source: Bloomberg)

Ease and cease. That’s what economists and traders are expecting from India’s central bank, which decides interest rates on Wednesday.

The Reserve Bank of India will cut the repurchase rate to 6 percent from 6.25 percent, according to 41 of 57 economists in a Bloomberg survey with the rest seeing no change. It’ll stay there at least through the end of 2018, a separate survey shows, as record-low inflation begins to reverse and the Federal Reserves reduces its balance sheet.

Investors will also be watching for the split between Governor Urjit Patel and his five voting colleagues on the monetary policy committee, after one member dissented for the first time at the last meeting, calling for a steep reduction. Pressure is building on Patel for a stimulus as India’s rising financial markets belie weak investment and mounting job losses.

"We expect the RBI to cut the policy rate by 25 basis points, while maintaining a neutral stance," said Kaushik Das, Mumbai-based chief India economist at Deutsche Bank AG. "Latest inflation developments have opened up room for cutting rates, but markets are not convinced that the central bank will be willing to signal a deeper rate cut cycle."

The monetary authority will announce its decision at 2:30 p.m. in Mumbai followed by a press conference 15 minutes later. Click here to follow TOPLive for real-time blog coverage of the decision.

Inflation Meltdown

Consumer prices rose 1.5 percent in June, below the RBI’s April-September forecast range of 2 percent to 3.5 percent, continuing to undershoot official forecasts. Core inflation -- stripping out volatile food and fuel costs -- slipped below the 4 percent medium-term target. What Patel & Co. will assess, though, is how much of this is fleeting and how much is entrenched.

Patel is wary of a looming increase in house rent allowances for government staff, elevated household inflation expectations, the prospect of higher minimum payments to farmers that would feed into food prices, and the risk of a write off on farm loans. Inflation will end the fiscal year through March at about 3.7 percent, according to a Bloomberg survey, while the RBI forecasts somewhere between 3.5 percent and 4.5 percent.

Fed Risks

Deutsche’s Das says that with the Federal Reserve likely to start unwinding its balance sheet in the coming months, the RBI would probably prefer to be on the sidelines in October. Foreign funds have been drawn to India’s high yields, with the rupee offering dollar-based investors about 10 percent this year, the highest returns in Asia.

Lower interest rates, on the other hand, will further squeeze the spread between U.S. and India, which shrunk to 410 basis points last month, the narrowest since February. That, and limited room available for foreigners to buy local debt after last week’s auctions, means overseas inflows could slow.

Growth Stutters

If inflation is due to rebound and the external situation isn’t the most opportune, why would Patel cut on Wednesday? He’ll ease policy because growth has slowed following Prime Minister Narendra Modi’s unprecedented clampdown on cash last year.

Moreover, the roll out of a nationwide goods and services tax has disrupted supply chains across the country. A private gauge published Tuesday indicated that manufacturing output contracted in July, with the index sliding to the lowest since the 2008/09 financial crisis. That doesn’t bode well for an economy where factories are already running at less than 73 percent of capacity, credit growth hovers near record lows and bad loans are forecast to rise from a 15-year high.

"Demonetization sidetracked these concerns and rhetoric since then was output gap will start closing once remonetization happens," said Soumya Kanti Ghosh, an economist at the country’s largest lender State Bank of India, referring to the cash ban. However, almost all MPC members flagged capacity underutilization as a key risk in the minutes of the RBI’s last meeting, he said, making him confident of a rate cut.

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