RBI Policy Preview: More easing in H2 2015

The Reserve Bank of India (RBI) will announce its monetary policy decision on 4 August. The central bank is expected to hold the key policy rates unchanged next week. However, the RBI's monetary policy stance is likely to turn softer in August as the probability of another 25bp repo rate cut later in H2 2015 is rising.

In its previous round of policy announcement on 2 June, the RBI had lowered the repo rate by 25bp, as expected, but had maintained a cautious policy stance. The three key risks that the central bank had highlighted were: 1) below-normal monsoon rains; 2) firming crude oil prices; and 3) volatility in external environment. While these risks cannot be completely ignored, developments on most of these fronts since early June had been somewhat reassuring.

1) Monsoon: In early June, the India Meteorological Department (IMD) had projected monsoon season (June-September) rains in India to be below normal, at 88% of the country's long period average (LPA). Against that, the cumulative rainfall to date - half-way into the monsoon season - stands normal at 96% of the LPA. The geographical distribution of rainfall has so far been a mixed bag - of the 36 meteorological sub-divisions in the country, the IMD suggests that 17 have received normal rains, six have received excess, while the remaining 13 have witnessed deficient rains so far. Thus, admittedly, while the geographical distribution of rainfall has not been ideal, the overall monsoon picture appears considerably better than was suggested by the IMD in early June. Nevertheless, clarity on the monsoon front ahead of the August meeting is only partial, but it will be considerably clearer by the RBI's next monetary policy meeting, scheduled on 29 September.

2) Crude oil price: Commodity prices in general have softened further since the RBI's June monetary policy meeting. The softening in oil prices had been particularly noteworthy - Brent crude oil price is c.US$54/barrel currently, versus c.US$65/barrel on 1 June. A flare-up in commodity prices, including in oil prices, is not expected in the near term.

3)   International environment: Volatility in international financial markets had indeed been on the rise in early July, driven by escalated uncertainly in the euro area following the Greek referendum. However, developments in the euro area later in July assuaged financial market volatility considerably. A likely hike in interest rates by the US Fed in the coming months remains an impending uncertainty. The first Fed rate hike is expected to take place in September. However, given India's generally sound macroeconomic parameters, the effect of a Fed hike on India will likely be relatively limited. The relative stability of INR and INR assets in general earlier in July, amid the heightened uncertainties in the euro area, remains a case in point in this context.

Accordingly,unless the monsoons turn markedly unfavourable during August-September or the effect of a Fed lift-off on India turns out to be considerably worse than current expectations, there is a case for further easing in H2 2015 by the RBI. The monsoon outcome will be largely clear by September, and the initial effect of a potential Fed hike - if indeed takes place in mid-September - on INR assets would be visible before the RBI's end-September policy meeting. The RBI's commentary and guidance next week will firm the views in this regard. 

"Given the ongoing soft inflation backdrop, the probability of another 25bp repo rate cut by the RBI in H2 15 is rising, in our view," says Barclays.