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The Reserve Bank of India (RBI) is expected to undertake a prolonged pause on rates; however, the probability of a last-in-the-cycle 25 basis points cut in the third quarter of this year, is rising, according to the latest report from DBS Research.
Amongst Asian peers, India witnessed the sharpest correction in inflation (January 2019 vs 2018 average) and has the most comfortable real rates buffer. Accordingly, the RBI-led panel was the first in the region to cut rates, on benign inflationary conditions and slowing growth.
April 2018-February 2019 CPI averaged 3.5 percent y/y, below the mid-point of the central bank’s inflation target band at +/-2 percent of 4 percent. The central bank lowered its inflation projections sharply for this year and next, at the February review.
There are incipient risks to the trajectory i.e. receding base effects, which could lift inflation towards 4.0 percent by end-FY20, food prices could mean revert after this current phase of disinflation, with a cobweb phenomenon in the production cycle, and the expansionary budget ahead of the general elections due in April-May.
However, despite these risks, evolving trends suggest FY20 will mark the third consecutive year of sub-4 percent inflation, the report added.
Changes in the policy rate impacts the economy primarily through; i) interest rate channel, (ii) credit channel, (iii) exchange rate channel, and (iv) asset price channel. Impact of the money market rates is usually immediate i.e. into commercial papers, treasury bills; in some instances, by equal magnitude e.g. call money rates.
The boost to domestic exchange rates also follows, with the scale and persistence hinging on broader risk sentiments.
"Policy transmission through banks has been gradual, much to the chagrin of the central bank. Regardless, the economy is headed into a soft patch in 1H19 beyond which a lift in postelection uncertainty and budgetary boost to consumption are likely to stabilise activity," DBS Bank further commented.
