On Tuesday, September 29, the Reserve Bank of India will announce its monetary policy and most market participants and the economist are hopeful of rate cut. Earlier last month at Jackson Hole, Governor Raghuram Rajan had mentioned that the Central Bank had cut interest rates thrice in the year and were still in an accommodative mode, this statement have fuelled their hopes of a rate cut.
In an interview to CNBC-TV18, economists, A Prasanna of ICICI Secutiries PD and Pranjul Bhandari of HSBC expect RBI to cut rates to the tune of 25 basis points.
Jahangir Aziz, JP Morgan expects a hawkish cut from RBI as opposed to dovish hold by Fed’s.
Bhandari says one should focus on the statement from RBI. She expects Governor Rajan to move from an accommodative stance which he has had so far to a more balanced stance.
Both Bhandari and Prassan expect the governor to lower the inflation target for January 2017.
According to all the economists, the key takeaway to look forward from the policy would be the inflation target for January 2017 and Rajan’s view on fiscal deficit.
Melwyn Rego, MD and CEO, Bank of India also believes it is more to important to watch out for the RBI statement on inflation than the rate cut per se.
He thinks there is every possibility of deposit rate and base rate cut by banks if RBI cuts interest rates. It is likely that the deposit rate and base rate would fall by 50 basis points, he adds.
Below is the transcript of Jahangir Aziz, A Prasanna and Pranjul Bhandari’s interview with Latha Venkatesh on CNBC-TV18.
Q: What is the combination you are expecting? Are you sure there is a rate cut and will it be accompanied by a lowering of both the RBI’s inflation and gross domestic product (GDP) forecast?
Prasanna: Our base case expectation is that Reserve Bank of India (RBI) will cut the repo rate by 25 basis points. And as far as our forecasts are concerned, we do think that inflation forecast for January-March will be lowered. In fact that will be the rationale for RBI to cut rates because they have guided markets using the six percent target they have for the January-March period. As far as GDP, yes, I think it is possible that it could also be lowered marginally.
Q: Similar question to you. Do you too expect rate cut to be accompanied by a lowering of GDP and inflation forecasts?
Bhandari: Yes, we are expecting a 25 basis point rate cut like the market, but I think the more important thing here is the change in stance. I think in this policy meeting, Governor Rajan will move from an accommodative stance which he has had so far to a more balanced stance. In some sense I think he has been preparing the market for it over the last month when he has made some speeches on the benefits of medium-term low inflation and I think he will formalise it in a policy statement in this particular meeting.
In terms of forecasts, yes, we think they are going to nudge down the March, 2016 consumer price index (CPI) forecast to about 5.5 percent. I also feel that they may extend out the inflation forecast to beyond just March, 2016 to sort of give a sense of the challenges that they are facing for the medium-term targets of five percent in 2017 and four percent in 2018 beyond that.
Q: What I have from both of you is, both of you expect a cut and both of you expect that at least the inflation forecast is going to be lowered closer to the five and half mark. What would be the first expectation on September 29? You are going with a cut?
Aziz: Yes, it is a hawkish cut. He is going to go and say that six percent is no longer the target. Even if we go below six percent, we really need to look 12-18 months ahead and that is a four percent target. And so, what are the financial conditions that are required in order for me to meet the four percent target. So, it is going to be a pretty hawkish cut as opposed to the dovish hold of the Fed.
Q: All of you agree that there is a cut. Do you also think that he will hint this is the last cut? The phrase that gave the previous pause a dovish pause was that we will look for emerging opportunity for accommodation. You expect that to be absent?
Prasanna: Yes, I expect that to be absent, but you should remember that in June also when RBI cut rates, those words were not present. So, essentially only in August, they reintroduced the words and if I remember correctly, these words were there in April also. So, it is some kind of a pattern which RBI seems to have been following. But, having said that, I agree, for the time being, we should expect this to be the last cut. But, I do not think immediately RBI will guide markets towards four percent. I think five percent will be the interim target for January, 2017 and four percent for January, 2018. So, RBI would like to proceed on that disinflationary path.
Q: One of the things the RBI could be noticing and at least some of the brokerages, notably JP Morgan concentrates on what you call the core core. Monsoons and global factors are giving us an advantage in terms of tradables and food, but what is our own contribution to inflation – that is the services inflation, education, health and medical services have fallen from 5.7 to 5.5 percent in the last number we have, August. Don’t think that there is a chance that that services inflation, the core core inflation can fall to probably 5.25 percent, that inherently more space can come, things which we do not see now but maybe what makes us so sure that services inflation will not fall to five percent by January?
Prasanna: That is not my point. I am not sitting here saying categorically inflation will not fall, but like you said, I think there is a lot of uncertainty around it and it will take time. So, what the RBI has been doing also if you look at the pattern of interest rate cuts is that they have been waiting for inflation to move down and then they followed it with cuts. They have not anticipated a move down in inflation in any of their cuts till now. That pattern will continue.
So, if inflation surprises all positively, much more than the trajectory which they lay out perhaps in this policy, then sometime next year, rate cuts are always possible. But that is the caveat which RBI will come out with and therefore it will be completely data dependant.
Q: What is your sense? There isn’t space; there is’t a likelihood that the core inflation will fall. Do you think RBI follows that?
Bhandari: Yes, I think it does but here I just want to highlight what I call the service inflation conundrum. It is interesting that the Wholesale Price Index (WPI) has been falling 5 percent year on year, CPI around positive 3.7 percent and the general thinking is that the difference is because services inflation, non tradable is generally very high in the country but if you look at the gross value added (GVA), the GDP data, services inflation number is running at minus 0.5 percent year-on-year, so on the GDP side you are not seeing any pressure on services. And when you break down that into further components, you realise that even services can be broken down further into tradable and non-tradable services. Things like trade and transport are running at a negative clip, but something like personal services, consumer services is still running at a positive clip, still running at 5-6 percent year-on-year and because the CPI accounts much more of this personal services, the space for rate cut from here is very narrow. It’s the choice of RBI to choose CPI over either GVA or over WPI.
Q: I would still think that why are we ruling out the possibility that services inflation won’t fall exactly the consumer services, medical, education. The last note from Sajjid Chinoy indicated that that one has fallen to about 5.5 percent. If it falls to 5.25, why should there not be space for more cuts?
Aziz: As Prasanna said, obviously there is uncertainty surrounding that and it can fall but the question is, as Prasanna said is data dependent. I do not think its data dependent to that extent. In inflation targeting framework you don’t care very much what happened in the past. You really care what is going to lie ahead of you. So even if services inflation falls to 5.25 percent, what are the economic conditions that will sustain it to fall let’s say to 5 or hold it at 5. In that case you have to come up with an argument that demand is significantly weaker than any of the indicators that are suggesting or that demand will become weaker in the next two-three-four quarters than what we are seeing now. So, I am not saying that you cannot get rate cuts; I am not saying that you cannot have inflation falling but you cannot have that and you cannot have growth at 7 percent or 8 percent. You need to stare at growth at 5 and that will bring down service inflation, all core inflation.
Q: At the moment we do not have that much data so you cannot expect the Governor to say that, right?
Aziz: We do not have the date, there is nothing that suggests that India’s growth is going to fall to 5 percent.
Q: Now the transmission issue – do you think liquidity has enabled some bit of transmission. After all post July we have had a slightly better with the call rate going below the repo rate practically for the entire period. Do you think the RBI will hint or will in fact keep liquidity higher to ensure transmission?
Prasanna: To some extent if you look at the market based measures or market based interest rates particularly at the short end, definitely they have benefited from liquidity being surplus and RBI has been intervening regularly to remove the surplus from the market.
However, it is essentially a product of RBI’s Fx intervention in the previous quarters which has lead to this situation and that situation won’t be persisting into the current quarter or the next for one, Fx flows have slowed down and therefore RBI’s activity in the Fx market has also slowed down and seasonally currency demand will be picking up next quarter, which means that the liquidity conditions will tighten and perhaps dip into mild deficit going into November and December.
Q: The other point which can perhaps push base rates down would be if the yields fell. The yield has been little stubborn at 7.7 mark. Do you think the RBI could perhaps open the floodgates more for foreign institutional investors (FII) money, FII infusion into debt? Will that be something you would watch out for or do you think the RBI’s hands are tied because that will strengthen the currency?
Aziz: That’s an extremely important question that on the short end of the curve the RBI delivers 75 bps of rate cut and the same RBI which is a debt manager of the government is unable to move the long end of the curve and that is the question that the government should be asking RBI – that’s a separate question.
I do not think the RBI thinks about bringing down the long-end of the curve by allowing more demand for government security – that would be the wrong reason to increase the limits.
Q: They won’t do that?
Aziz: I do not think. There might be other reasons why he wants to do that. He want to increase the diversity of the pool of investors who hold government securities etc, but to raise it because I want to bring down the long end of the curve is not something that the RBI will be willing to do at this point in time.
Q: What would you be looking out for? You would of course be looking out for whether that phrase emerging opportunity is there in the text but what would you be watching out for other than what we discussed?
Bhandari: As I said earlier I will be watching out for a clear move from accommodative stance to a balance stance. Repo rate being bought down to 7 percent which is the long-term average; it’s the average across different business cycles. It is a level at which the economy — the RBI think it’s on balance. The RBI will want to be there and by just being there and it signals that it’s open to emerging space opening up but as of now it doesn’t see that space and therefore it plans to remain there for a prolonged period at this point.
There is going to be very clear discussion on the next two medium-term targets, 5 percent and 4 percent and the challenges and prospects of reaching those. I am also hoping that the RBI speaks a bit about the upcoming challenges on 7th Pay Commission, possibility of inflationary challenges from the GST. It will be good to see what they think about these few challenges which might be there in the next 12 months or so.
Q: What would you watch out for?
Prasanna: Essentially broadly along similar lines but it will be important for RBI to stress that 5 percent as interim target and 4 percent only kicks in from January 2018. If they start guiding market using 4 percent as a target then market could get spooked; bond market is not prepared for that for within 12 months for RBI to target 4 percent.
Q: What would you watch out for from the statement?
Aziz: The Governor has tried very hard to separate India’s monetary policy decision from that of the Fed. I think he is going to keep on doing that. All I want to know is that how hard he has to struggle in this statement to say that whatever the confusion that was caused by the Fed and what Janet Yellen statement was, to what extent even that doesn’t have an impact on his monetary policy view.
So when does that become a problem because we know that that is a binding constraint even though the Governor both in the press conference and the statement has tried very hard to separate India’s monetary policy from that of the US Fed.