In ICRA’s view, the balance of risks appears tilted in favour of a Repo rate cut rather than a pause in the Reserve Bank of India’s (RBI’s) August 2015 review of monetary policy, as long as the monsoon rainfall and kharif sowing remain on track in the remainder of July.
Naresh Takkar, Group CEO and Managing Director, ICRA Ltd. said, “Concerns related to the key inflation risks highlighted by the RBI during its June 2015 policy review have ebbed in recent weeks, with the smaller than feared monsoon deficit, moderation in crude oil prices and relatively stable currency. CPI inflation seems likely to undershoot the Central Bank’s projection of 6.0% in January 2016, brightening the prospects of a Repo rate cut of 25 bps during the ongoing quarter, provided that food prices remain in check. An early reduction in the Repo rate may be warranted, as tighter liquidity post the onset of the busy season would impede the process of transmission to Bank lending rates.”
The deficit in monsoon rainfall relative to the long period average (LPA) stands at 7% (up to July 22, 2015), smaller than the 12% shortfall forecast by the Indian Meteorological Department (IMD) for the monsoon season in 2015. Despite this shortfall, kharif crops have been sown on an area that is 9% higher than the norm for mid-July, and planting has already covered over half of the normal kharif area of 105 million hectare. Additionally, the increase in minimum support prices (MSPs) for most crops has been modest.
Furthermore, with a decline in the vulnerability of India’s external account, the INR-USD exchange rate has remained relatively stable in recent weeks. Moreover, crude oil prices have eased meaningfully since the June 2015 policy review, with the average price of the Indian basket declining from ~USD 64/barrel in May 2015 to ~USD 57/barrel in July 2015 so far. The pass through of the same to lower retail prices of fuels, in conjunction with a favourable base effect, is likely to dampen CPI inflation below 5% in July-August 2015, in ICRA’s view.
Notwithstanding the uptick in June 2015, CPI inflation has averaged 5.2% in the first half of this calendar year. Factors such as the modest rise in MSPs for various crops and benign global commodity prices are expected to result in CPI inflation averaging a moderate 5.2-5.4% in H2CY15.
Despite the current surplus liquidity conditions, the transmission of the cumulative 75 bps of rate cuts in January-June 2015 to Bank deposit and, in turn, lending rates, has been gradual, partly constrained by the lack of downward reset of interest rates for various small savings schemes for 2015-16. With systemic liquidity likely to tighten post the onset of the busy season for credit offtake in the third quarter, an upfronting of the next rate cut to the August 2015 policy may, to an extent, support a quicker transmission of monetary easing to Bank lending rates, in ICRA’s view.
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