Home / Opinion / Measured cut, accommodative policy stance likely by RBI

The Reserve Bank of India (RBI) will likely cut the repo rate by another 25 basis points (bps) in its forthcoming monetary policy announcement next week. The broad macroeconomic backdrop—a benign inflation trajectory, only a modest recovery in economic activity and a disciplined fiscal stance—remains conducive for monetary easing. A basis point is one-hundredth of a percentage point.

The RBI commentary is expected to maintain an accommodative bias, potentially highlighting the central bank’s intent to support banking system liquidity in the coming months. While the possibility of a 50 bps repo rate cut next week cannot be completely ruled out, we assign a low probability to such a scenario.

RBI has already delivered 125 bps of cuts in less than 15 months and has relatively few “bullets" left in the current easing cycle. Accordingly, a 25 bps rate cut, along with accommodative commentary, should be governor Raghuram Rajan’s preferred policy action in April.

However, I expect RBI to deliver another 25 bps cut in the months to come, eventually taking the repo rate to 6.25% by mid-2016.

Given that a rate cut in the April meeting is widely expected, the tone of RBI’s commentary will likely be watched closely. The bank’s commentary was materially more cautious in the early part of the current easing cycle—say, up to mid-2015. Accordingly, despite the repo rate being lowered by 75 bps during H1 2015, the softening in bank lending rates was limited.

On the other hand, the last rate cut—in September 2015—was not only a larger 50 bps, it was also accompanied by a more accommodative policy guidance. As such, RBI could achieve better transmission of the September repo rate cut into bank lending rates.

I feel it is important for RBI to maintain an accommodative bias in its commentary in order to achieve better monetary transmission. Recent lowering of interest rates in small savings schemes should help in better transmission of RBI’s monetary policy signals.

Another factor that can be of critical support for better monetary transmission is RBI’s guidance, if any, related to its liquidity operations in the coming months. The central bank has been markedly cautious with regard to injecting liquidity into the banking system in recent years, including most of 2015. As a result, reserve money growth—which reflects the central bank’s injection of primary liquidity—averaged only approximately 7.5% year-on-year during the four-year period of 2012-2015, markedly lower than the longer term average of approximately 13%. However, given the persistent pressure on banking system liquidity in recent months, we expect the central bank to continue to inject liquidity, including via open market operations during 2016-17.

While the global backdrop remains challenging, India’s domestic macro-fundamentals remain on a stronger footing. The key advantage ahead of the April policy is a benign inflation trajectory. We expect the headline Consumer Price Index to average approximately 4.8% during 2016, undershooting RBI’s “target" of 5% and staying way below its long term average of over 7%.

Inflation at the wholesale level has already recorded year-on-year contractions for 16 consecutive months, a pattern not witnessed in India in over four decades. Better food price management despite challenging weather conditions, sustained idle industrial capacity and softer global commodity prices augur well for inflation staying anchored in the coming months. Demand-driven pressure on inflation remains largely absent. Although the rupee is likely to weaken against the US dollar during 2016, it is not expected to materially alter the otherwise subdued inflation trajectory.

Recovery in economic activities remains modest. Manufacturing continues to face headwinds. Consumption remains by and large supportive, but the recovery in private capex remains markedly weak, reflecting large and persistent excess capacity. On balance, one cannot completely rule out downside risks to our existing headline GDP growth forecast of 7.8% during 2016-17.

Moreover, considerable “grey" areas persist under the new methodology of India’s national income accounting as we feel that there is an upside bias in growth estimates under the new series. Under the old methodology, we think India’s 2016-17 GDP growth rate would have been around the mid-6% mark, lower than its trend growth rate. Given this, the “new" growth prints need to be interpreted carefully; seemingly high headline GDP growth should not be seen as any obstacle for monetary easing.

Siddhartha Sanyal is chief India economist at Barclays Bank Plc.

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