India rates outlook

Inflation in India has been exceeding the RBI’s target range this year, making a further cut to the repo rate at the bank’s August monetary policy committee meeting less of a certainty even as the bank’s commitment to spurring growth remains in play. Nevertheless, for the time being we are maintaining our outlook for a year-end rate of 3.5%, implying a further 50bps of cuts from the current 4.0%. As the RBI noted in May, with growth floundering ‘the policy space to address growth concerns needs to be used now rather than later to support the economy.’

Real rates have turned negative

Source: Bloomberg, Emirates NBD Research

The Reserve Bank of India was already adopting a looser monetary policy stance even before the outbreak of the coronavirus pandemic, after India’s 4.2% real GDP growth in fiscal 2019/20 (ended March) was the slowest in eight years – only part of which can be attributed to the virus. The RBI has cut by a cumulative 115bps since the start of the year, with an unscheduled cut of 40bps in May taking the benchmark rate to a record low of 4.0%. Even in doing so, the MPC’s communiqué underlined the prospect of further cuts, stating that all members were in favour of the cut and for ‘maintaining the accommodative stance as long as it is necessary to revive growth and mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target.’

The inflation prints over the past six months raise some questions regarding what the August decision will be, given that CPI inflation has averaged 6.6% over January to June – some measure above the 4.0% ± 2 percentage points target range. However, the 6.1% June figure was the lowest since March, and indications are that much of the recent upward price pressure has been driven by supply chain dislocation as a result of Covid-19-related lockdowns. With some of this expected to ease, a favourable monsoon promised (boding well for food prices), oil prices set to remain relatively low and demand pressures fairly weak, inflation is expected to moderate in H2, potentially giving the RBI the space to cut further over the remainder of the year and to maintain the growth stimulus it has pledged.

India FX reserves, USDbn

Source: Bloomberg, Emirates NBD Research

This is despite the fact that doing so would keep real rates in negative territory, as the bank is clearly prioritising boosting growth over maintaining any portfolio inflows into its local debt market. Arguably, it has been given the room to do this by India’s first current account surplus in over a decade over the January-March quarter, which will almost certainly have been followed by another in the period ended in June. A lower trade deficit drove the reversal, and with oil prices having remained low, while other imports will likely have dipped during the lockdown, this trend will have continued. Equally, India’s services exports were likely less constrained by the pandemic than the trade in goods.

INR has been comparatively stable

Source: Bloomberg, Emirates NBD Research

India already saw a decline in foreign portfolio investment into debt over January-May (offset partially by greater foreign interest in equities), and this will likely have accelerated, but the improvement in the current account should grant the RBI the firepower to deal with these outflows without prompting a run on the rupee if it cuts rates further. Foreign reserves have risen USD 46bn so far this year to a record high of USD 507bn, over 12 months’ of import cover.