Not the end of the easing cycle, expect more rate cuts in FY17
The Reserve Bank of India left policy rates unchanged as expected in the policy review on Tuesday. After a frontloaded rate cut of 50bps in the September policy review, the central bank is now focussing on full transmission of the previous policy rate cuts (only half have been transmitted so far), developments on inflation front as also fiscal stance of the central government after recommendations of the Seventh Pay Commission. Broadly, it expects the dis-inflation trajectory to persist over the coming year and noted that it will look through any temporary rise in inflation due to hike in house rent allowances recommended by the Pay Commission. As regards growth, it expects gradual recovery. In all, it was a status quo policy in action, guidance and even forecasts. We see this as a temporary pause (which may continue in February policy review as well) and not the end of the easing cycle. In its policy review, RBI maintained status quo on the key interest rates in line with our and Street expectations. Rationale for the policy stance was that the RBI had frontloaded its rate cut in the last policy and would like to wait for more data and focus on the transmission of past policy rate cuts, which have not happened to the full extent. In terms of forecasts, it maintained its March 2016 CPI forecast of 5.8% and FY16 GDP growth of 7.4%, with mild downside risks to both. The guidance was neutral to dovish with the central bank clearly stating that monetary stance still remains accomodative. Going forward, two key variables are likely to determine the RBI’s monetary stance. In FY17, implementation of Seventh Pay Commission recommendations is likely to push CPI housing higher (HRA allowances of government employees are used as inputs for computing CPI housing). The central bank has mentioned that it will look through such a rise in CPI as it is largely technical in nature. Further, RBI has mentioned that it does not expect Seventh Pay Commission to boost aggregate demand, as it will be offset by budgetary tightening as the central government stays on fiscal consolidation path. This clearly suggests that the central bank expects fiscal consolidation in FY17. With regard to GST impact on inflation, the central bank’s stance was ambiguous. Overall, it expects disinflation to continue in FY17 and government to continue with fiscal consolidation. While the central bank has paused, it has very clearly stated that monetary stance remains accommodative. With regard to the next policy on February 2, 2016, we expect a pause as the central bank waits for FY17 Union Budget (likely towards end February). However, this is not the end of the easing cycle and we expect rate cuts to resume again in FY17.