India's central bank could see reasons for a surprise rate cut, economists say

Saheli Roy Choudhury

Updated Wed, Feb 6, 2019, 10:15 PM

The Reserve Bank of India (RBI) could cut the rate at which it lends to banks on Thursday due to shifting economic conditions, Priyanka Kishore, head of India and Southeast Asia economics at Oxford Economics told CNBC.
Several factors could prompt the RBI to reverse its policy, including a downtrend in headline inflation, according to Kishore.
Other economists, however, warned while food and fuel prices were low, India's core inflation was still near the top end of the RBI's target.

The Reserve Bank of India could cut its benchmark interest rate at which it lends to banks on Thursday, due to shifting economic conditions, an economist told CNBC.

That call may surprise some because the RBI, in its last monetary policy statement in December, reiterated its stance of "calibrated tightening" — meaning there would not be a rate cut in the near term. At the moment, the central bank's policy repo rate is at 6.5 percent.

"My base case is for a cut today, but even if that doesn't happen, I think it just gets delayed to April," Priyanka Kishore, head of India and Southeast Asia economics at Oxford Economics, told CNBC's " Squawk Box " on Thursday.

Kishore said there were several factors that could lead the RBI to reverse its policy stance: the downtrend in headline inflation, a softening economic growth outlook, and a fragile shadow banking sector where lending abilities of the non-banking financial companies have been reduced.

In December, India's headline inflation dropped to an 18-month low of 2.19 percent, according to Reuters. The RBI's medium-term inflation target is between 2 and 6 percent, so the December number was at the tail end of the range.

"If I just look at the economic backdrop, then yes, a cut is justified," Kishore said.

Jeff Ng, chief economist for Asia at Continuum Economics, mirrored Kishore's view, saying he also expected a rate cut on Thursday.

"The slowing inflation trend gives reason enough for the central bank to start thinking of cutting rates now," he told CNBC's " Capital Connection ."

"Cutting in April will be too close to the (general) election so we believe that having the rate cut today will help support the domestic growth," he added.

Shift to a 'neutral' stance

Thursday's meeting will be the first for new RBI Governor Shaktikanta Das and the consensus among market watchers is that he would announce a shift toward increased caution.

Around two-thirds of 65 economists polled by Reuters said they predicted the central bank's monetary policy committee to hold the repo rate at 6.50 percent, and most said they expected a shift in the RBI's stance from "calibrated tightening" to "neutral." Nearly half of the respondents had said they predicted a 25 basis point rate cut by mid-2019.

Still, Vishnu Varathan, head of economics and strategy at Mizuho Bank, wrote in a Thursday note that the RBI's shifting of gears should not be "mistaken as precursor to an imminent dovish swing."

He explained that, while the headline inflation fell at the end of 2018 on declines in fuel and food prices, it is set to pick up to around 3 to 4 percent in 2019. Additionally, he said, core inflation, which excludes fuel and food prices, "remains far stickier" at 5.5 to 6 percent, which is near the top end of the RBI's target.

"Inflation is policy relief (easing tensions) but not grounds for policy relaxation," Varathan said.

Fiscal deficit

In last week's interim budget , the government announced 750 billion rupees ($10.56 billion) to support poor farmers and slashed the tax burden for the lower middle class, ahead of the parliamentary elections.

That would put the government's fiscal deficit target for the year ending Mar. 31 at 3.4 percent of GDP, higher than the 3.3 percent it had previously predicted.

The government's rural package, steadily increasing off-balance sheet spending and doubts about some of the fiscal projections could make the RBI "wary about the inflation impact down the line," Samiran Chakraborty, chief economist for India at Citi, wrote in a recent note.

The monetary policy committee "will have to judge whether the fiscal package by infusing cash into the rural economy could trigger an early reversal in food deflation or not," he said.

Mizuho's Varathan also pointed out that support for India troubled banking sector may instead be a policy priority, to help ease liquidity and capital for restructuring to proceed smoothly. Moreover, despite the government's optimistic revenue estimates, its borrowing costs may end up being higher than expected as it aims to fund its policy promises.

"The RBI will have to at least hold back on easing to lean against such fiscal risks," Varathan added.

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