Amidst clamour for a rate cut, RBI held on to its monetary stance by retaining repo rate at 8%. While raising caution about the transitory nature of base effect and a probable uptick in food inflation in the near term, the central bank lowered its March 2015 CPI forecast to 6%. It also now expects inflation to average around that level in the coming 12 months predicated on a normal monsoon and no adverse supply-side or financial shocks. With threat of imported inflation receding due to softening of commodity prices and a reasonably stable currency, RBI believes that risks to its January 2016 CPI target of 6% are evenly balanced at the current juncture. However, the central bank remains open to cut rates early next year (including outside the policy review cycle meaning March 2015) if the extant disinflation momentum strengthens, inflationary expectations in the economy starts waning and the government delivers on fiscal consolidation.
Expect 75-100bps easing in 2015
The policy outcome and commentary is in line with our belief that RBI wants to play safe and be sure about disinflation being driven by more structural than frictional factors. This also implies that once the policy stance is shifted the subsequent actions would be consistent with it. As we expect that inflation bounce in the watch period of Dec 2014 to Feb 2015 would not be worrisome, the central bank could announce the first rate cut in February or March 2015. Overall easing in 2015 is likely to be 75-100bps.
Commercial banks to start lowering lending rates soon
RBI highlighted that transmission of the benefits of eased liquidity conditions such as lower average call rate, decline in pricing of CDs, softening of wholesale deposit rates and recent cuts in retail term deposit rates has been absent so far despite weak credit growth. Therefore, well-rated corporate have been substituting short-term bank loans with CPs raised at much cheaper rates. In our view, many commercial banks would announce term deposit rate cuts soon as wholesale deposits are available at lower rates and also with retail inflation coming down dramatically, the real return has turned positive after two years. This should subsequently allow them to take Base Rate reduction or ease spreads over it.
Retains FY15 GDP growth forecast at 5.5%
RBI has retained its GDP growth forecast for FY15 at 5.5% with expectation of credible pick-up in economic activity during Q4 FY15. It believes that backdrop is congenial for a turnaround with moderating inflation, easing commodity prices and input costs, comfortable liquidity conditions and improving business confidence. The central bank hopes that the government would be able to revive investment cycle soon by addressing issues related to infrastructural constraints and inadequate supply of key inputs such as coal, minerals and land. A strong policy effort should dispel the drag on the economy emanating from weak agri growth and sluggish exports.