RBI likely to ease monetary policy and repo rate may 7.25%

The Reserve Bank of India (RBI) is likely to reduce its repo rate 25bps to 7.25% in its meeting on 2 June. It last reduced the rate in an inter-meeting move in March. CPI inflation remained subdued at 4.87% y/y in April. Core inflation, though marginally higher at 4.32% y/y, has remained within a narrow range of 4.15-4.47% in the past five months. Although analysts are concerned about the forecast of less-than-normal monsoon rain and the risk of larger increases in the Indian government's procurement prices due to increased rural distress, Standard Chartered believes currently low inflation and favourable base effects until August 2015 will prompt another rate cut next week.

In addition to the policy action, markets will closely watch the RBI's monetary policy stance to assess the possibility of even more rate cuts after June. Such expectations have been muted, but recent comments from India's economic advisor on the case for more interest-rate cuts and RBI Governor Rajan acknowledging still-weak economic growth have raised expectations of more cuts. 

"However, the tone of the next Monetary Policy Statement (MPS) will provide clarity on direction. Rates-market participants also expect a 25bps repo rate cut at the coming meeting. However, Indian Government Bonds (IGBs) seems to have not completely priced in a cut yet. 1Y-5Y IGB yields is likely to decline 10-15bps if the RBI delivers the cut. The new benchmark 10Y IGB yield trades at 7.65%, c.20bps lower than the previous 10Y benchmark IGB. The benchmark 5Y IGB yield is c.7.85%, and a scope for this to decline further", according to Standard Chartered. 

In addition to expectations of monetary easing, supply dynamics in June suggest that IGB redemptions will exceed planned issuance by INR 82bn. The 25bps cut will also be in line with FX market expectations, and as such is unlikely to trigger a significant move in USD-INR. If the RBI does deliver the cut, FX market reaction will likely depend on the MPS and market expectations of the policy rate trajectory. Given broader US dollar (USD) strength in recent weeks, the pressure on USD-INR remains to the upside. Standard Chartered bank forecasts USD-INR to be 64.50 by mid-2015 and 63.00 by end-2015.