Reserve Bank of India likely to cut key rate by 25 bps in February, says Societe Generale

The Reserve Bank of India is likely to go for a rate cut during its meeting tomorrow, noted Societe Generale in a research report. This would be the third meeting to be chaired by Urjit Patel. During his first two meetings, Patel surprised the market by cutting the policy rate in the first meeting when the market expected the central bank to stand pat. In the second meeting, the central bank made no changes when the market expected a cut. The RBI is expected to lower the key interest rate by another 25 basis points during its upcoming meeting, added Societe Generale.

The Indian central bank does not foresee a near-term downside risk to the economy because of demonetisation. This might have resulted in major demand destruction particularly in the cash-oriented rural economy and sectors like hotels & restaurants, retail trade and transportation and unorganised sector.

“With the demonetisation scheme resulting in the withdrawal of 86 percent of the currency circulation in one fell swoop, we expect economic disruption to persist through four consecutive quarters”, stated Societe Generale.

The disruption is likely to begin from the fourth quarter of 2016 as demand destruction and resultant job loses result in a negative spiral. The problem has been worsened further by slow process of remonetisation. Finance Minister Arun Jaitley’s recent budget might have given enough support to Patel as he decided to give up any temptation to opt for populist measures.

“All these factors, we believe, will provide Patel with enough monetary policy space to go for a rate cut in the hopes of boosting flagging demand. We have, therefore, pencilled in a cut of 25bp in the repo rate (to 6 percent from the existing 6.25 percent) from the meeting”, said Societe Generale.