Expect more positive surprises from RBI in next few quarters
The repo rate cut by 25 bps to 6.25% was a direct policy response to plunge in food inflation momentum. The MPC also noted that food price management by the government will have a moderating effect on prices over the next few months. Even as RBI still sees some upside risk to 5% inflation by March 2017, we think the new MPC regime’s flexible approach to inflation targeting and readiness with regard to lower real rates allows more room for rate cut. We pencil in another 25 bps cut in FY2017. The October 4 policy was a close call but the Monetary Policy Committee (MPC) unanimously voted for a 25 bps repo rate cut to 6.25%. The MPC’s guiding factors for the decision were: (1) sharp downward shift in food inflation momentum, which is key to future inflation trajectory and (2) several measures announced by the government, especially for pulses, which could help in moderating price pressures over the next few months. However, the committee took cognizance of the cost push pressures, which are likely to emerge from 7CPC awards and increase in minimum wages with possible spillovers through MSPs and rural wages. The money policy statement indicates CPI inflation at 5.0% in 3QFY17 and 5.3% in 4QFY17. This is significantly higher than our estimates of 4.3% and 4.5% respectively. This raises scope for some positive surprise for RBI over the next couple of quarters given that high frequency indicators have been indicating further fall in vegetables and pulses prices along with favourable base effects. RBI also highlighted that domestic growth generation will miss the crucial driver of global demand, which will keep the pressure on India’s growth. We believe that targeted inflation is gradually moving away from the 4% point target of March 2018. The MPC is likely to be more attuned to keeping inflation within the band (as mandated by the government notification). RBI estimates 4QFY18 CPI inflation at 4.5%, which includes 7CPC-related impact as well as hike in minimum wages-led impact (total impact of 15 bps). If RBI follows the range, without point target, it can open up room for further rate cuts. The MPC minutes on October 18 will help gauge the thought process of the committee members. Even as RBI estimates CPI inflation slightly above 5% in the coming months, we believe that RBI will be surprised on the downside. We expect inflation to average around 4.5% in H2 of FY17 and with output gap remaining negative, any upside risk emanating from the demand side will be contained. Further, as we noted earlier, the MPC regime seems to be comfortable with the flexible inflation approach of 4% (+/-) 2% in the medium term and may not follow the implicit target of 4% by end-FY2018 set by former Governor Rajan. This gives scope to account for growth as well. Meanwhile, the post-policy communications by RBI indicated that it may also not follow the rigid real interest rates target of 1.5-2.0%, which was advocated until now and argued that India would also be impacted by the structural lowering of global neutral rates. We believe that RBI’s latest communication and expected comfortable inflation dynamics over the next few months augur well for further 25 bps cut in FY2017, though based on RBI’s own estimates it will be difficult to argue for any further rate cut.