The Reserve Bank of India (RBI) is expected to reduce the key policy rate or the repo rate by 25 basis points (bps) to 6% in at its monetary policy review meeting scheduled for August 2 while maintaining neutral stance on interest rates.
If the RBI does cut repo rate, this could only be the second such instance by the monetary policy committee (MPC) since it was established in October 2016.
The expectation of a rate cut is mainly due to decreasing retail inflation,which eased to 1.54% in June — a record low, after reading 2.18% in May.
The benign consumer inflation reading for successive months has made economists to believe that inflation may have fallen to 4% on a durable basis.
Inflation for June was lower than the target band of 2-6% set by the RBI.
“India may have already become a 4% inflation economy,” said Pranjul Bhandari, chief India economist, HSBC. “We expect the RBI to cut the policy repo rate by 25bps on 2 August to bring it down to 6%,” she said in a note to its clients.
RBI has changed in stance to neutral from accomodative in its February which surprised market participants. However, the during the last policy review in June, the central bank revised its inflation projection downwards to 2-3.5% in the first half of the year and 3.5-4.5% in the second half — opening up the possibility of a rate reduction.
The earlier projection for the retail inflation in first half of the fiscal was 4.5% and 5% in the second half.
Importantly, one of the members of the Monetary Policy Committee, R.H. Dholakia, voted for a 50 bps rate cut during the last policy meting in June.
“Considering this slippage in inflation, coupled with the fact that forward-looking factors that earlier had clouded the inflation outlook had also turned out to be relatively benign, we therefore expect the RBI to take up one more rate cut in the August meeting,” Morgan Stanley said in a report which also expects a 25 bps cut.
While most economists expects a 25 bps rate cut on Wednesday, the RBI is holding on to its neutral stance. Opinion is divided whether there would be further rate cuts.
While Morgan Stanley ruled out further rates cuts beyond August, Ms. Bhandari of HSBC expected another rate cut if inflation remained well below 4% in the second half of the financial year.
“We see a risk of another 25bps rate cut if inflation remains well below 4% in 2HFY18,” she said.
Economists said the market will react positively if, on August 2, the central bank says further monetary policy action would be data dependent. “If RBI delivers a 25bps rate cut next week and says that future policy action will depend on how data evolves in the next few months, this should be supportive for market sentiments, as it will signal that the central bank is not ruling out possibility of further rate cuts in the period ahead, as long as the data supports such a stance,” said Kaushik Das, India chief economist of Deutsche Bank.
