RBI likely to cut interest rates again in June, concerns remain over RBI’s independence: Capital Economics

The Reserve Bank of India (RBI) is expected to use the current low rate of headline inflation as justification for a third consecutive rate cut at the conclusion of its policy meeting on Thursday, June 6, according to the latest research report from Capital Economics.

But with a growing perception that the central bank is allowing its control of inflation to slip, further policy loosening raises the risk that inflation rebounds strongly and ultimately requires interest rates to be higher in future.

RBI Governor Shaktikanta Das has wasted little time in leaving his mark on monetary policy since taking the position in December. In both policy meetings so far this year, the MPC has voted 4-2 to cut interest rates by 25bp.

As such, the repo and reverse repo rates have dropped by a cumulative 50bp to 6.00 percent and 5.75 percent respectively – entirely reversing the hikes from last year when Dr Urjit Patel was at the helm, the report added.

Given the environment in which the previous two cuts have taken place, further loosening seems likely next week. National accounts data due for release on Friday (May 31) are likely to show that GDP growth slowed again in Q1 2019 to 6.5 percent y/y, from 6.6 percent y/y in Q4.

Notwithstanding the usual caveats about the accuracy of India’s official data, that would be the weakest pace of growth in two years.

"With the global emphasis also turning to looser policy, we are forecasting another 25bp cut in both the repo and reverse repo rates next week," Capital Economics further commented.

The longer-term concern is that the RBI’s credibility as an inflation fighter is being eroded under the new governor. The strength of Prime Minister Modi’s mandate following the recently-concluded general election will do little to ease those fears, given that Mr Das has close connections to the Prime Minister.

Meanwhile, an undermining of the RBI’s credibility would partially reverse the success the central bank has had in reining in household inflation expectations since 2013. Inflation expectations have a reasonably good relationship with core inflation.