RBI expected to cut rates for first time in 10 months on low inflation, but doubts remain

Image: Danish Siddiqui / Reuters


Pure numbers do not necessarily always tell the complete story. This is what the monetary policy committee (MPC) headed by the Reserve Bank of India (RBI) Governor Urjit Patel has been indicating in the previous months.

The MPC which has met five times since being formed in September 2016, has been cautious in its approach to cut interest rates. Only once in October 2016 (Urjit Patel’s first monetary policy meeting as RBI Governor) did they cut rates. Rates have been on hold since. A whole range of factors, starting with demonetisation in November last year, Donald Trump taking the White House in the US, the US Federal Reserve rate hike and strengthening of the dollar, were all factors which kept the MPC cautious when it came to downward revision of rates quickly.

Now the clamour for a cut in interest rates is growing, with inflation at a record low. So if we look at just the numbers, there could be no better time for the RBI to announce a cut in the benchmark repo rate. And this is what a majority of economists and analysts expect the RBI to do – effect a 25 basis points cut – when it announces its action on Wednesday (August 2) afternoon.

India’s consumer price inflation (CPI) for June 2017 stands at 1.54 percent, a record low. Inflation has been falling due to lower food prices. The repo rate – at which the central bank lends to commercial banks – remains unchanged at 6.25 percent.

“We stick to our forecast at the lower end of the rate cut possibility range. We expect the RBI to cut the policy repo rate by 25bps on 2 August to bring it down to 6 percent,” HSBC Securities and Capital Markets (India) chief economist Pranjul Bhandari says. She forecasts another 25 basis points rate cut if inflation remains well below 4 percent in the second half of FY18.

HDFC Bank analysts also expect a rate cut. “While some of the inflation drivers could well be temporary, the RBI cannot afford to completely overlook the softness in core inflation. Over 40 percent of its components have shown a sustained decline, corroborating the fact that the real economy is running well below its potential,” Abheek Barua, chief economist with HDFC Bank says.

Despite the obvious possibility of a rate cut on Wednesday, a small section of analysts suggest that the RBI might just want to maintain status quo.

Siddhartha Sanyal, chief India economist of Barclays is amongst the few who is not expecting a rate cut. “This is a close call [to predict what the RBI will do],” he says. Sanyal fears that inflation – which has come down due to unusual softening in food prices in the early summer – could soon claw back to the 4 percent level. Oil prices are also expected to fall further.

In that scenario, he feels, the MPC, would want to have the conviction that inflation will continue to sustain at the current lower levels, before deciding to cut rates.

Nikhil Gupta and Rahul Agrawal, analysts at Motilal Oswal Securities believe that the RBI has sufficient room to cut policy rates by 50 basis points and stick with its neutral guidance, but warn that a disappointment could not be ruled out. “However, the ghosts of past stance and the challenge of a simultaneous change in the mindset of three committee members [of the MPC] might postpone the rate cut to October (2017). In any case, a 50 basis points rate cut is imminent.”

Besides the action that the RBI could take, it will be interesting to see if the RBI changes its monetary stance back to accommodative, from neutral.