RBI likely to change interest rate during monsoon

IMD is forecasting below-normal rainfall, at 93% of long period average (LPA), between June-September, according to its late-April projections. However, a private agency, Skymet, has been forecasting normal monsoons, at 102% of LPA. Nonetheless, this has triggered fears of another sub-optimal monsoon season, which could affect food production and, in turn, food prices.

In India, food makes up a large share of its CPI basket (c.46%, including manufactured food items), and weather conditions play a major role in determining agro prices. However, the geographical and temporal distribution of rainfall will likely play a key role in determining the effect of the monsoon on the final outcome, and greater clarity on these factors will be available only by Q3 15. Food inflation has softened materially over the past year despite sub-optimal weather conditions, and food price inflation seems to be stabilizing around 6% y/y after averaging over 11% pa during 2009-14. Analysts feel that, among other things, the government's stance of more active management of food stocks, allowing only a modest increase in the minimum support prices (MSPs) for agro commodities, and its stronger vigilance have played a major role in containing food inflation and inflation expectations, which is a key success in the India context.

"Monsoon rainfall will be an important determinant in RBI's monetary policy stance. After the two inter-meeting cuts in Q1 15, the RBI kept its key policy interest rates unchanged in April, but continues to display a clear dovish bias. Another 25bp cut in the repo rate on 2 June is expected, which would take the repo rate to 7.25%. The possibility of further easing beyond June remains contingent upon greater clarity around the monsoon rainfall and its impact on 2016 inflation trajectory, along with a potential Fed rate hike in H2 15. Given that continued benign trends in inflation and inflation expectations could provide room for further easing, analysts note the risk of further cuts in the repo rate cut beyond our June forecast", according to Barclays.