Mumbai: The Reserve Bank of India (RBI) is expected to cut its key policy rate by at least 25 basis points (bps) on Tuesday, according to economists and bankers who are divided on the central bank’s ability to reduce borrowing costs further at a time the US Federal Reserve is preparing for its first rate increase in nine years.

Economists and bankers at 10 top banks surveyed by Mint are all of the opinion that the RBI will cut its repurchase rate, the rate at which it lends to commercial banks, to 7%.

It will be the fourth rate cut this year by RBI, which has reduced the repo rate by a total of 75 bps over the three previous occasions.

One basis point is one-hundredth of a percentage point.

Consumer price inflation eased to a record low of 3.66% in August from 3.78% in July and the Fed kept US interest rates unchanged at near-zero levels on 17 September, giving RBI governor Raghuram Raghuram room to cut the RBI’s benchmark rate at least one more time in the current monetary policy cycle.

Had the Fed raised rates, it would have been difficult for RBI to contemplate a cut in the face of an expected outflow of funds from emerging markets. The decline in inflation has also kept RBI on course to containing the rate based on the consumer price index within its 6% target by January.

In a recent interview with the Financial Times newspaper, finance minister Arun Jaitley said inflation is “very much under control" and the country was well positioned to ride out any global economic turbulence. “Common sense says the rates should come down," Jaitley said,

Rajan may not have the leeway for more rate cuts. Fed chairperson Janet Yellen said on 24 September that she expects US rates to start rising this year.

“An expectation of a capital outflow from the country may prove to be a hindrance in further rate cuts," said Abheek Barua, chief economist at HDFC Bank Ltd.

Rajan said on 18 September, a few hours after the Fed’s decision to hit the pause button, that the stance of the 29 September policy will follow the path that the central bank laid out in its last monetary policy statement on 4 August.

“Significant uncertainty will be resolved in the coming months, including the likely persistence of recent inflationary pressures, the full monsoon outturn, as well as possible Federal Reserve actions. As the Reserve Bank awaits greater transmission of its front-loaded past actions, it will monitor developments for emerging room for more accommodation," the central bank said then.

The economists and bankers polled by Mint said uncertainty has been resolved, with inflation staying within RBI’s comfort zone, the Fed delaying its rate increase and commercial banks beginning to lower borrowing costs.

“All the conditions put in the guidance have been met. The Fed has exercised a pause, banks are lowering rates, the full monsoon picture has now emerged and it is not very worrying as the government was successful in dampening price rises in food, especially that in pulses. Inflation is in check," said Saugata Bhattacharya, chief economist at Axis Bank Ltd.

Economists are divided about how much more room RBI has to cut rates beyond Tuesday.

Gaurav Kapur, chief economist at Royal Bank of Scotland Plc.’s Indian unit, expects Tuesday’s cut to be the last in the current fiscal year to 31 March. Going beyond, RBI may cut rates by 50 basis points more, he said.

“It could possibly be a prolonged easing and can extend up to 2017," Kapur said.

State Bank of India’s chief economist Soumya Kanti Ghosh said there is an “outside chance of another 25 basis points cut if inflation numbers continue to surprise on the downside".

Besides lowering the policy rate, RBI may raise the cap on bond investments by foreign entities, some economists said.

Although the increase in the limit may not be outright, denominating the investment limit in rupee terms, instead of the dollar, will open up more room for foreigners to invest in Indian bonds. That’s because the current limit expressed in dollars is premised on an exchange rate of 49.77 per dollar; on Monday, the rupee closed at 66.05 per dollar.

Assuming the conversion rate at around 60 rupees per dollar would free up at least 30,000 crore of space more for the foreigners to invest in bonds. Foreign portfolio investors can invest up to $81 billion in Indian bonds, out of which $30 billion is reserved for government bonds.

anup.r@livemint.com

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