More Rate Cuts Expected As RBI Takes Over Stimulus Baton
We expect further rate cuts by the Reserve Bank of India (RBI) in 2009, bringing the benchmark repo rate down to 4% by the end of FY2009/10 (April-March) as the central bank attempts to cushion the ongoing slowdown in growth. Moreover, the new government will most likely signal that the scope for further fiscal stimulus is limited given India's precarious credit rating, effectively passing the baton to the RBI to support growth.
The Reserve Bank of India (RBI) continued its easing cycle at its April 21 meeting, cutting the repo rate and the reverse repo rate by 25bps each to 4.75% and 3.25%, respectively. The cash reserve requirement (CRR) ratio was, on the other hand, held flat at 5%.
The announced rate cuts come as wholesale price inflation lingers around zero (0.18% y-o-y in the week ending April 4) and looks likely to dip into negative territory in Q209 (calendar year), as high base effects set in and economic activity remains in the doldrums on the back of an uncertain outlook for both external demand and the domestic economy following the April-May general elections.
In its annual policy statement for FY2009/10 (April-March), the RBI stated that it expects the economy, with the assumption of a good monsoon, to expand by 6% in the new fiscal year, after an expected 6.5- 6.7% expansion in FY2008/09. This is a full percentage point above our more bearish 5.0% GDP growth projection, giving further reason for the RBI to continue its monetary easing over the fiscal year as growth disappoints.
In addition, the central bank stated that it expects growth in the wholesale price index (WPI) measure to drop into negative territory in early FY 2009/10, but to finish the year at 4%, which is broadly in line with our own projections of WPI inflation averaging 3.4% over the fiscal year. This means that WPI inflation should remain considerably below the RBI's short-term objective of 4-4.5% for much of the fiscal year, which, combined with below-trend growth, should pave the way for further rate cuts.
Moreover, both money supply and credit growth look likely to slow further over the fiscal year, dipping deeper below the RBI's FY09/10 projections of 17% and 20%, respectively, at least in the short term. The RBI announced on March 26 that it would buy government securities in the open market amounting to INR800bn (US$16bn) in the first half of FY09/10 in order to boost liquidity conditions, in what effectively amounts to quantitative easing. However, we do not expect this to have a marked effect on lending conditions other than to reduce New Delhi's borrowing costs by depressing government bond yields. The yield on the benchmark 10-year bond yield fell 20bps to 6.19% following the policy announcement on April 21 and look likely to drop further towards 5.5% or even lower in the medium- term as the RBI begins its purchasing regime.
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Limits On Fiscal Spending Puts Onus On RBI To Support Growth
We believe the case for further monetary easing is strengthened by India's strained fiscal position, with the central government's fiscal deficit expected to remain on the wrong side of 5% in FY09/10. Indeed, the RBI estimated in its annual policy statement that the combined fiscal deficit for the central and state governments would mount to about 9% of GDP in FY08/09, with special securities issued by the central government outside of the market borrowing programme adding 1.8 percentage points to this figure. The large budget deficit has raised fears about India's debt position with rating agency Standard & Poor's downgrading its outlook on India's long-term sovereign debt from stable to negative on February 24, and S&P's competitor Moody's keeping India’s sovereign ratings under surveillance. Although we caution that the outcome of the ongoing national elections is far from certain, we expect that the new government will most likely signal that the scope for further fiscal stimulus is limited given India's precarious credit rating, effectively passing the baton to the RBI to effect further easing to support the economy.
We thus expect further rate cuts from the RBI over the course of 2009, bringing the repo rate down to 4% by the end of FY09/10, with a concomitant cut in the reverse repo rate to 2.5%. In the near term, we expect at least one more 25bps cut in both the repo and reverse repo rate looks likely ahead of or at the RBI's next scheduled meeting in June.
Risks To Outlook
The main risk to our interest rate outlook is stubbornly high consumer price inflation (CPI), which came in at 9.6% y-o-y in February. While we expect the contraction in wholesale prices to eventually feed through into the consumer price index, we still see CPI remain in the high single digits for much of the fiscal year, which is likely to constrain the RBI's easing ambitions.
Another continuing problem for the RBI in its policymaking is the reluctance of commercial banks to pass on the policy rate cuts to customers. The lending rates of the five major commercial banks have fallen less than 200 basis points since October 2008, when the RBI commenced its easing cycle, which now amounts to 425bps in total. Were this situation to persist, which is not unlikely given that banks will want to increase their margins in the face of the increasingly negative outlook for the economy, it may make the RBI less inclined to further reduce rates.
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Table: India – Monetary Policy
2005 2006 2007 2008 2009 2010 2011 2012 2013 Lending rate, %, eop 1,5 10.75 11.50 13.25 13.00 10.50 11.00 11.00 11.00 10.00 Real Lending Rate, %, eop 2,6 5.44 4.78 5.38 4.97 3.50 6.00 6.00 6.00 5.00 Consumer prices, % y-o-y, eop 7 5.3 6.7 7.9 8.0 7.0 5.0 5.0 5.0 5.0 Consumer prices, % y-o-y, ave 7 4.2 6.8 6.2 9.2 7.0 5.0 5.0 5.0 5.0 Exchange rate INR/US$, eop 3,8 44.97 44.11 39.38 48.58 48.00 48.00 48.00 46.00 44.00 Exchange rate INR/US$, ave 3,8 44.01 45.18 41.17 43.40 48.29 48.00 48.00 47.00 45.00 Wholesale prices, % y-o-y, eop
7 4.0 5.9 7.4 0.6 4.0 5.0 5.0 5.0 5.0
Wholesale prices, % y-o-y, ave 7 4.4 5.4 4.6 8.4 3.4 4.3 5.2 5.0 5.0 Central Bank policy rate, % 4,9 6.50 7.75 7.75 5.00 4.00 6.00 6.00 6.00 6.00 Exchange rate INR/EUR, eop 3,8 53.24 58.21 57.45 68.01 59.52 63.36 66.24 59.34 55.88
Notes: e BMI estimates. f BMI forecasts. 1 Calendar Year; 2 Real rate strips out the effects of inflation; 3 Calendar
years; 4 Repo Rate, End of fiscal year; Sources: 5 IMF. 6 IMF/BMI; 7 Ministry of Statistics; 8 BMI; 9 Reserve Bank of India
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