Time running out for RBI on rate cut

A Bank of America Merrill Lynch Global Research report titled ‘India Economic Watch’ points to key aspects of the current economic scenario to advocate a rate cut by the RBI’s Monetary Policy Committee

The Reserve Bank of India (RBI)’s Monetary Policy Committee (MPC) should cut rates by 25bps on August 2, with June CPI at 1.5 per cent, below RBI’s 2-6 per cent target. Core CPI posted a weak 3.7 per cent.

The following factors are to be noted:

1July CPI was at 2.1 per cent.

2May Index of Industrial Production (IIP) growth was a weak 1.7 per cent.

3Rains are advancing, pushing up sowing 18.7 per cent above 2016.

An August RBI rate cut would signal a lending rate cut to banks before the busy season begins in October.

The bottom line 1.5 per cent CPI and 1.7 per cent IIP = 25bps RBI cut on August 2.

We grow more confident of our call that the RBI MPC will cut rates by 25bps on August 2 after June inflation, at 1.5 per cent, expectedly slipped below the RBI’s 2-6 per cent inflation target.

Three reasons for RBI easing

First, inflationary pressures remain muted. Core CPI inflation also slipped to a low 3.7 per cent. We are tracking July CPI inflation at 2.1 per cent building in a temporary tomato price hike.

Second, we do not see the output gap closing any time soon with high rates constraining old GDP series growth, at a sub-potential 5.5-6 per cent. Industrial growth, at a tepid 1.7 per cent in May, reinforces the case of high lending rates resulting in anaemic recovery.

Finally, the monsoons are advancing reasonably well at 99 per cent of normal. Autumn kharif sowing is 8.9 per cent higher than last year. On balance, the RBI is expected cut to signal a 25bps lending rate cut before the busy industrial season sets in October. Delays in RBI rate cuts would endanger the much-needed bank lending rate cut before the busy industrial season sets in October.

 

RBI MPC’s inflation concerns dissolving

4Low 1.5 per cent June CPI; 2.1 per cent July: June inflation; at 1.5 per cent (1.5 per cent BofAMLe), expectedly slipped below the RBI’s 2-6 per cent inflation target. July inflation is being tracked at 2.1 per cent, building in a temporary tomato price spike. Minimum support price (MSP) hikes have also been modest (up to 8 per cent). The RBI has cut its inflation forecast to 2.5-3.5 per cent from 4.5 per cent in 1H FY18 and 3.5-4.5 per cent from 5 per cent in 2H FY18.

5 3.7 per cent core CPI: Core CPI (adjusting petrol and diesel) is falling rather than sticky. The RBI now finds that “the industrial outlook…indicates that pricing power remains weak”.

61.7 per cent May IIP = Output gap: Unlikely to close any time soon as high rates delay recovery. Old series GDP growth, at 5.5-6 per cent, even with the new IIP series, is within our estimated 7 per cent potential. The RBI now acknowledges the “…the deceleration of activity…been in operation since Q2…”

100 per cent of normal monsoon so far, 8.9 per cent jump in cropping: Rains are advancing at 99 per cent of normal as of season to date, with El Nino fading. Autumn kharif sowing is 8.9 per cent higher than last year.

7GST rates: Unlikely to be inflationary.

8Imported oil inflation: Risks coming off on lower oil prices and a softer US dollar. Oil strategists have cut the FY18 dated Brent price to $50/bbl from $61/bbl.

9HRA inflation fears overdone: The Centre’s house rent allowance (HRA) is cut to 24 per cent of basic pay from 30 per cent now; will revert to 30 per cent when dearness allowance crosses 50 per cent.

10Sufficient differential with the US Federal Reserve Bank: We do not see the Federal Reserve Bank tightening as a constraint for the RBI’s August 2 rate cut. Our US economists expect the Fed to hike again only in December. Even so, the rate differential would still be almost 500bp.

RBI rate cut to signal lending rate cut before busy season

We believe time is running out for the RBI to cut rates. If the RBI MPC cuts rates on August 2, it would signal a lending rate cut to banks before the busy industrial season sets in in October. Real lending rates are running at a 20-year high at a time when the global recession could stretch beyond the Great Depression. As 2015 showed, unduly delaying RBI rate cuts into the busy season only delay the transmission to bank lending rates into the next slack season beginning April.