Indian economic growth likely to remain above 7 pct in 2016, RBI may further lower rate by 25bp in December

In the first half of this year, the Indian economy expanded 7.5 percent year-on-year, a rise from 7.3 percent in 2015. The economic growth was mainly driven by the domestic sector. But the solid headline number hides the persistent weakness in private investment and exports. For this year as a whole, the economic growth is expected to remain above 7 percent, especially given the good monsoon that should underpin the agriculture sector and domestic demand in general, said Commerzbank in a research note.

“For 2016 and 2017, our forecasts are below consensus because of weak exports, lackluster private investment and the slow progress on land, labour and banking reforms so far”, added Commerzbank.

However, the positives for the Indian economy might come via private consumption, which would be assisted by the 7th Pay Commission award, rural consumption because of good monsoon, cumulative cuts of 175 basis points to 6.25 percent from last year and robust public investments in roads and railways, stated Commerzbank.

On the central bank front, the Reserve Bank of India deliberately maintained tight monetary policy in 2014 in an attempt to control inflationary expectations. As inflation has eased, this provided the path for the central bank to begin lowering rates in 2015. The RBI cut rates last year by a total of 125 basis points to 6.75 percent. It further cut rates by additional 50 basis points to 6.25 percent in 2016.

“We look for a further 25bp cut on 7 December. However, this will be contingent on stability in the financial markets”, noted Commerzbank.

An inflation target range of 2 percent to 6 percent until March 2021 has been adopted by the nation. Actually, it is more of a narrower range of 4 percent to 6 percent in the medium term given that structural factors suggest at least 2 percent inflation.

If the central bank misses the target for three straight quarters, it would be needed to explain to the government and to highlight remedial actions. Before 2015, the central bank had considered a series of criteria, including growth, inflation, the cost of servicing government debt, and currency stability.

“The formalization of an explicit inflation target should help to anchor inflation expectations given concerns over elevated inflation in the past,” according to Commerzbank.