Forbes India 15th Anniversary Special

Climate conducive for RBI to ease interest rates

Economists believe it may happen earlier than anticipated

Salil Panchal
Published: Sep 12, 2014 06:32:24 AM IST
Updated: Sep 12, 2014 04:29:59 PM IST
Climate conducive for RBI to ease interest rates
Image: Reuters

Reserve Bank of India (RBI) governor Raghuram Rajan may be a little more reticent now than when he took charge over a year ago, but macro-economic conditions for the country are improving fast, which will make the bank better placed to consider easing interest rates soon, economists say.

The RBI has maintained its anti-inflationary stance for months, but economists who spoke to Forbes India say the macro-economic conditions could push the bank to be dovish on interest rates “earlier than anticipated”.

The RBI has kept rates unchanged since April this year and is expected to do the same when it meets next on September 30. But several economists have forecast an easing of rates in the quarter to March 2015.

Deutsche Bank in its latest report titled: ‘The dial is turning from vicious to virtuous’ says that declining crude oil and coal prices coupled with a dip in demand for gold would result in “multi-layered benefits for the Indian economy, its external accounts, capital markets and savings profiles,” according to its analysts Abhay Laijawala and Abhishek Saraf.

In a separate report, Barclays analysts say that with growth prospects improving,  inflation starting to stabilise and continued fiscal consolidation, India’s sovereign foreign currency ratings could move up to the high BBB (from current low BBB levels) by 2017.

The previous Congress-led government spent much of its second term battling factors like high inflation, rising interest rates, high current account deficit–as imports outstripped exports (due to hefty oil and gold imports), a weak currency and a threat of a downgrade on its investment ratings.

But some of these concerns have eased.  The Deutsche Bank report says that decelerating oil demand strengthens the case for lower oil prices. The International Energy Agency has downgraded demand estimates from 1.3 million barrels of oil per day (mmbpd) in January 2014 to 0.9 mmbpd now.

The fall in global oil and coal prices will be a huge positive for India, they add. Energy imports constitute about 33 percent of India’s total imports.

At the broader level, these positives, alongside the optimism of improved corporate earnings and a kickstart to structural reforms, are being mirrored in record stock market levels. The benchmark Sensex index has jumped over 20 percent since the start of the new fiscal year.

Explaining the impact of falling oil prices, Deutsche analysts estimate that in fiscal year ending March 2015, oil subsidies could fall by 44 percent year-on-year–the sharpest drop in any one year since fiscal 2010-to $13 billion and by a further 42 percent in fiscal year 2015-16 to $ 9.6 billion, on a fall in oil prices and increase in diesel retail prices.

Further, as the demand for the yellow metal fades in India–it lost its rank as the biggest consumer to China last year–it would trigger “a much needed shift away from physical savings to financial savings through bank deposits, mutual funds and insurance,” Deutsche analysts said.

On the ratings front, Barclays analysts Krishna Hegde, Siddhartha Sanyal and Rahul Bajoria say the key drivers to a ratings upgrade would be an improvement in fiscal dynamics and also improvement in governance standards. The latter would help India rise from its current rank of 134, according to the World Bank.

“We think that the government’s commitment to reducing the central fiscal deficit to three percent by FY2016-17 is strong,” the Barclays team says.

They also expect that over the next few years, India’s rankings on a number of worldwide governance indicators could return to levels which were last seen in 2003.

Barclays economists also expect the capitalisation of Indian banks to improve (in line with Basel norms) in coming years, which would raise the chances of a ratings upgrade.

Most economists with large global banks and brokerages have raised their growth forecasts for India, which could rise close to six percent by fiscal year 2015-16.