Ind-Ra: RBI May Keep Rates Unchanged in August Policy Meeting

The Reserve Bank of India (RBI) is likely to wait and watch on rates in its third bimonthly credit policy meet in August, says India Ratings and Research (Ind-Ra). There is room for RBI to cut rates by another 25bp; however, a more appropriate time for a rate cut would be 2HFY16. Amid evolving growth-inflation dynamics, Ind-Ra expects the policy stance to reflect RBI's continued intention to anchor both inflation and inflationary expectations. This has become even more important for RBI after its agreement with the government of India to follow a framework of inflation targeting.

Wholesale Price Index inflation has remained negative for the last eight consecutive months and stood firm at negative 2.4% in June. Consumer Price Index (CPI) inflation remains lower than RBI's guided path target of 6%. Growth in headline CPI inflation accelerated to an eight-month high of 5.40% yoy in June 2015 compared with 5.01% yoy in May 2015, predominantly due to higher food inflation and diminishing base effect. Price increases in some protein-rich items such as pulses, milk and meat caused food inflation to rise to 5.5% in June from 4.8% in May.

 

The impact of unseasonal rains has also become visible, with a lagged impact on the prices of vegetables and is most pronounced in case of onion. Kharif sowing so far has been encouraging and the rainfall on all India basis till 29 July 2015 was only 3% lower from the long period average. Yet the risk to Kharif crops in view of India Meteorological Department's prediction of less than normal monsoon remains.

The base effect on inflation will also wane further in the coming months. For Wholesale Price Index, it will kick in from August 2015 and for CPI it will be more pronounced from September 2015, putting pressure on inflation. However, Ind-Ra still expects CPI inflation to remain in the comfort zone of RBI.

In its second bimonthly review, RBI chose to front-load a rate cut of 25bp on the assumptions that (i) the government would carry out efficient food management to mitigate the inflationary effects of less than normal monsoon (ii) there will be a limited increase in agricultural support prices (iii) there would be adequate quantity of seeds/fertilisers for supply to farmers, crop insurance and adequate credit facilities (iv) the government would release food stocks on time and repair disruptions in food supply chains, if any, through imports. RBI will monitor their progress as the monsoons season pans out.

The central bank will also want to wait for cues from the US Federal Reserve on the timing of their interest rate hike. US Fed is likely to tighten policy for the first time in a decade this year, probably in September.

RBI has cut rates by a cumulative 75bp since January 2015; however, banks on an average have reduced their base rates by 25bp and deposit rates by 50bp. Credit growth has also slipped below 10% from the medium-term average of 21%, limiting the transmission of RBI rate cuts into lending rate cuts.

The key to defining the magnitude of rate cuts will depend on incoming data on CPI inflation compared to RBI's expectation of inflation trajectory. Given the acceleration in the June headline CPI inflation and the increase in core CPI for the third consecutive month, RBI is likely to see how the monsoon season pans out and keep rates on hold in the August monetary policy meeting. Ind-Ra expects average the headline CPI inflation to come in at 5.4% in FY16, which we believe should create room for RBI to lower rates by a further 25bp during 2HFY16.

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