RBI monetary policy: Falling inflation gives room to Urjit Patel to cut rates; will he do it today? - Firstpost

RBI monetary policy: Falling inflation gives room to Urjit Patel to cut rates; will he do it today?

The Reserve Bank of India (RBI), at the bi-monthly monetary policy meet today, will announce its decision on interest rates as set by the six-member Monetary Policy Committee (MPC). This is also governor Urjit Patel’s first monetary policy after he has taken charge as the RBI governor in September.

Theoretically, the time is ripe for another rate cut now, but the RBI may wait till December to do so.

RBI governor Urjit Patel. Reuters

RBI governor Urjit Patel. Reuters

Since January 2015, the RBI has cut the repo rate by a cumulative 150 bps. The rate currently stands at 6.5 percent. The Consumer Price Inflation (CPI) trajectory, gives one strong reason to expect a rate cut at the earliest. At the last reading (in August), the CPI inflation fell to 5.05 percent compared with 6.07 percent in July.

The RBI has a March, 2017 target of 5 percent inflation. Most economists believe that inflation might well fall below that level during this period given that monsoons this year have been favourable, enabling better crop output. Food price inflation, the main villain in the inflation story, has eased considerably in the recent past, giving room for further rate cuts.

Most economists, however, expect the Monetary Policy Committee (MPC) to advise RBI to hold its rates for now and cut rates in the December policy. This is because by then the RBI will have more data on the trend of food prices, the impact of monsoon and can weigh other upside risks to inflation such as the impact of the 7th Pay Commission. What is also critical is besides the announcement on interest rates, the language of the policy too will also be watched closely for cues on the future course of RBI’s action on various areas. This will include any likely change in the course of ongoing bad loan clean-up exercise and RBI’s outlook on economy. “The Reserve Bank of India’s (RBI) policy communique will be more critical than its rate action for the market to ascertain the future path of interest rates,” India Ratings and Research said in a note.

“There are some good reasons why a rate cut could materialise in the upcoming October 4 meeting. The recent fall in food prices has been sharper than expected, and cutting earlier keeps the RBI a safe distance away from possible Fed hikes. Yet our base case is for a rate cut in December. This is because, by December, two new inflation prints which are expected to be well below 5 percent will be available,” said Pranjul Bhandari, Chief India Economist, HSBC and Dhiraj Nim, economics associate at HSBC in a note.

“Moreover, given that the RBI was highlighting upside risks until its last meeting, it may prefer to move in steps, i.e. change the outlook on inflation now and cut rates in December. Furthermore, to get more bang-for-the-buck for monetary transmission, the RBI may want to get through the period of foreign currency non-resident (FCNR) deposit outflows before it cuts more,” the HSBC economists said.

In the 9 August monetary policy, the RBI had highlighted the upside risks to inflation. “Risks to the inflation target of 5 percent for March 2017 continue to be on the upside. Furthermore, while the direct statistical effect of house rent allowances under the 7th CPC’s (Central Pay Commission) award may be looked through, its impact on inflation expectations will have to be carefully monitored so as to pre-empt a generalisation of inflation pressures. In terms of immediate outcomes, much will depend on the benign effects of the monsoon on food prices,” the RBI said.

In a note, CARE ratings too said chances are high for a status quo in rates. “While we believe there will be no change (70 percent probability), the chances of a rate cut (30 percent probability) has surfaced after border tensions escalated last week. Also, given that this would be the start of the bust season, there would also be a justification on the economic front,” said CARE. That said, one cannot rule out a surprise rate cut if the MPC chooses to cut rate now before the US Fed rate action comes in December. One must remember that there has been calls for rate cuts from the government in recent months.

The bottomline is this: Going by the inflation trends, one shouldn't be surprised if Urjit Patel announces  a rate cut at 2:30 pm for reasons as explained above. But chances are more for the rate cut bonanza to come in December.

(Data contribution by Kishor Kadam)

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