Almost no one in the analyst community expects Reserve Bank of India Governor Raghuram Rajan to cut key interest rates during his monetary policy review tomorrow.
Rajan was widely expected to cut the repo rate, at which RBI lends to the banks, tomorrow, but the governor caught the market by surprise two weeks ago with an unexpected, and out of the cycle, cut of 0.25 percentage points.
Given the impending Budget, Raghuram Rajan is unlikely to announce any cuts tomorrow, and is only likely to do so in April, said Bank of America-Merrill Lynch economists today. Instead, they expect him to set the ground for future cuts.
“We expect the Reserve Bank of India (RBI) governor Raghuram Rajan to turn even more dovish (on interest rates) this Tuesday than the January 15 statement,” they noted. “He will likely cut rates by 25bp again in April. After all, banks are unlikely to cut policy rates till the slack season sets in April-September.”
“We expect 50bp more in 2015 and 50bp in 2016, with CPI inflation set to undershoot its 8% January 2015 and meet its 6% January 2016 targets (Charts 1-2). This should support our expectation of a slow recovery to 6.3% growth in FY16 from 5.5% in FY15 in the old GDP series. We have penciled in 25bp rate cuts each in April and June,” they added.
However, preventing a smooth series of rate cuts would be actions by international central banks, especially the European Central Bank, which recently cut rates to stimulate growth, and the US Federal Reserve, which is expected to start increasing rates soon.
Tomorrow, “we expect Governor Rajan to raise concerns about contagion when the Fed raises rates (in September, according to our US economists). The RBI will also likely highlight his concerns about ‘competitive monetary easing’ – that we fully share – especially after last week’s ECB Qantitative Easing,” they added.
If unprepared, India could see another bout of decline in its currency’s value in September when the US Fed increases interest rates at home. A higher interest rate in the US would result in a flow of money from India to the US, in turn weaking the rupee. Mere talk of ending the stimulus in the US had led to the Indian rupee falling from around Rs 50 to about Rs 68 to the dollar.
“We continue to expect Gov Rajan to recoup FX reserves to fight possible contagion when the Fed raises rates in September. We expect him to talk about his concerns about monetary easing, especially after last week’s ECB QE. If it consistently buys
FX, our BoP forecasts that the RBI can reach 10 months’ import cover by March 2016, well above the critical eight-month import cover needed for INR stability (Table 2 and Chart 5). This assumes oil at US$55/bbl in FY16.”
Similar sentiments were echoed by economists at Anand Rathi Securities.
“We do not expect any change in the policy rate during the policy
meeting scheduled for 3rd Feb’15. However, we expect the rates to be lowered further after the Union Budget is proposed on 28th Feb’15. Another 75-bp rate-cut during the rest of CY15 looks likely,” they said.
“Dr Raghuram Rajan in his earlier policy statements: “… will not hold rates high and longer than necessary” and “…including outside the policy review cycle”. He walked his talk when he reduced the policy rate by 25bps on 15th Jan’15, immediately after the release of inflation data (both CPI and WPI) for Dec’14. He did not wait for the 3rd Feb’15 policy meeting. Since there have been no additional data releases, at the next policy meet the RBI is likely to maintain the status quo.”
Another reason would be the growing fiscal deficit – the gap between what the government gets and what it spends. A slowing economy has hit tax collections, the economists pointed out.
“At the 15th Jan’15 monetary policy Dr Rajan focused on “sustained high quality fiscal consolidation” for further rate cuts.
The fiscal deficit for 9MFY15 has already hit the full-year target. Revenue collections in 9MFY15 have grown only 9.4% (vs. 11.1% a year ago) and the slowdown has been broad-based. On the positive side, 4QFY14 saw a revenue surplus (revenue collection picks up toward the fiscal year-end). This may occur in 4QFY15. By selling stakes in SAIL and CIL the government has moved nearer to its `634bn Plan target for FY15. But achieving the fiscal targets (both in absolute terms and percentage of GDP) is difficult, which makes the , the Union Budget on 28th Feb’15 crucial.”