RBI maintained status quo in August, citing rise in inflation and upside risks to 5 per cent projection of March 2017.
We foresee a 25 basis points cut in repo rate in the forthcoming monetary policy review on October 4. Recall, that RBI maintained status quo in August, citing rise in inflation and upside risks to 5 per cent projection of March 2017.
Since then, the headline inflation has fallen sharply and more importantly, further disinflation is in store over next few months as pulses prices deflate.
Thus, the headline CPI will likely slip towards the 4 per cent level in the interim before rebounding modestly, though it would likely undershoot RBI’s target of 5 per cent by the end of FY17. One may argue that RBI would wait till December for further confirmation of disinflation trend, but we think the Monetary Policy Committee (MPC) will be uncomfortable cutting rates very close to a potential Fed rate hike.
Importantly, the forthcoming policy review will be the first one under the six-member MPC and we would closely watch the views expressed by the three external (new) members to gauge its reaction function. Any clarity on MPC’s approach to 4 per cent CPI target by March 2018 would be very welcome.
In the last policy review in August, data till June was out and inflation had risen to 5.8 per cent (from 4.9 per cent in March).
Further, the July print was also expected to rise and exceed the 6 per cent level. This resulted in RBI citing upside risks and Street ruling out further easing.
However, things have changed materially since then. The July print was 100bps lower than the August print at 5 per cent.
A sharp disinflation in vegetable and meat prices led this fall. Going ahead, deflation in pulse prices will start getting factored in, which should result in headline inflation falling further towards 4 per cent, before it starts to inch higher in Q4 of FY17.
Nonetheless, inflation is likely to undershoot the RBI’s 5 per cent target by end FY17.
This should provide comfort to RBI.
The upcoming monetary policy review will be the first one to be conducted under MPC. We will watch out for two things: First, what is the positioning of the 3 new (external) members of the MPC, on a dovish-hawkish spectrum. This will give us some sense of the reaction function of the MPC. Secondly, we would look for any clarity on MPC’s approach to the 4 per cent CPI target by March 2018. These aspects are critical in shaping the future path of interest rates.
In light of the above considerations, we foresee a rate cut in the RBI policy review on October 4. The RBI’s commentary will be keenly watched given it is the first policy under MPC. Comments from the three new members will be of particular importance.
For now, given sharp disinflation and still weak recovery, we stick to our call of 50bps easing in rest of FY17 (including the October cut).