The Reserve Bank of India (RBI) cut its policy interest rate by 25 basis points Friday, in line with market expectations. This is the third consecutive reduction by 25 basis points since January this year. However, in its policy statement, the central bank cautioned there was little space for further reduction in interest rates because of high inflation, high current account deficit and production constraints in the economy.
Analysing the statement, Sonal Varma, Nomura India told CNBC-TV18 that 'little space' surely does not mean no space. So, the most likely scenario is that it is going to be a very gradual rate easing cycle with one rate cut surely on the cards.
She said global commodity prices and capital inflows into India would drive the extent and timing of rate cuts going forward.
Samiran Chakrabarty, Standard Chartered Bank is of the view that RBI’s decision for further rate cut will depend on quality of growth. "I would probably be biased more towards one rate cut, maybe at most two," he added.
He told CNBC-TV18 that if the RBI feels that the supply side of the economy is improving, they will be comfortable in pushing up demand, otherwise they might just hold on to the rate cut regardless of how the inflation is behaving.
Ashish Vaidya, UBS AG is of the view that at present the economy is in a lower rate trajectory because inflation and growth moderating but is not sure of how much RBI will cut.
Below is the verbatim transcritps of their interview on CNBC-TV18
Q: What would you expect the Reserve Bank of India (RBI) is saying when it says it has little space for further easing? Are you counting in one more cut at all?
Varma: Little space surely does not mean no space, so there could at least be one more cut. He has set the bars very high in terms of Gross Domestic Product (GDP) at 5.7 percent, Wholesale Price Index (WPI) inflation at 5 percent by March. So, it will actually take a lot in terms of inflation surprising on the downside, growth continuing to surprise on the downside to get the RBI to actually move. So to that extent he has set the bar very high which is consistent with the little space that he has mentioned.
The other thing is if he wants to bring down WPI inflation to 5 percent which is obviously possible depending on the scenario on global commodity prices. What it means is that if we are in a rising commodity price environment then the extent of growth sacrifice which will be required to get WPI at 5 percent will be much higher. On the other hand if commodity prices actually remain stable or decline then the space for the RBI to cut rates further to support growth will also be much higher.
They are getting into very uncertain, uncharted territory now where we need to watch both the movement on global commodity prices and the movement on capital inflows into India and that is going to drive the extent and timing of rate cuts going forward.
Q: The next mid-quarter credit policy is on June 17 and the next quarterly is on July 30 – do you expect a cut any of these times?
Chakrabarty: It is quite possible to get a rate cut now in the next quarter because this is the time when inflation is likely to be very soft. In that sense we also expect in the second half of the year inflation to inch up, so, in that respect this is probably the ideal time to do it.
However, at the same time I would think the quality of growth will matter immensely in Reserve Bank’s decision. If they feel that the supply side of the economy is improving only then they will be comfortable in pushing up demand. Otherwise, they might just hold on to the rate cut regardless of how the inflation is behaving. After all, consumer price index (CPI) is going to stay pretty high so that can always be used as an excuse for not cutting rates.
Q: How many more rate cuts are likely you think?
Varma: Broadly, subject to the economy behaving the way RBI expects it to, not more than two 25 basis point cuts for rest of the year. At this stage that seems likely outcome.
However, we need to watch commodity prices and the flow situation and things can be either more aggressive or less aggressive depending on how those two variables play out.
Q: What do you expect by way of rate cuts?
Chakrabarty: I would probably be biased more towards one rate cut, maybe at most two. A 5 percent inflation target is a significant one. RBI is very close to that end point so they would probably not like to stimulate the economy too much right now with lot of rate cuts.
Q: I was a little surprised when you said two rate cuts. The language and argument seems to indicate that there may not be so much space. Are you discounting the fact that the RBI in the past also sounded hawkish but given cuts in subsequent policies? Why are you routing for two? I would have thought that they are sounding more cautious than that.
Varma: Little space means only one rate cut but we need to understand what is happening here. The RBI is worried about the imbalances in terms of sticky inflation, high Current Account Deficit (CAD) and by delaying the rate cutting cycle the RBI is doing two things, one it is actually weakening demand quite substantially which in itself is going to start correcting the imbalances and second like you said if nominal GDP is lower tax revenues will be lower. It will actually put more pressure on the government to keep its spending under control and also to accelerate the approval process on the investment side.
So the point here is that by delaying the rate cuts the RBI is doing a lot of good by correcting the imbalances in the economy which it is worried about. If the imbalances correct, which will now start to happen in this financial year then this idea of space being limited will be tested. At this stage the direction on rates is clearly lower. The timing of the rate cuts will depend on how soon the imbalances correct.
However, the slow pace that the RBI is taking right now the imbalances will correct in the economy and probably towards the later part of the year, or maybe early 2014 you could see more rate cuts. So we should not get bogged down to one or two or three at this stage. The most likely scenario is that it is going to be a very gradual rate easing cycle with one rate cut surely on the cards.
Q: You have had time to read the document in full. What have you made of how bond yields have headed today and will head over the next eight weeks?
Vaidya: The broad thing which I can figure out is that the CAD is an important worry accompanied by inflation, commodity prices and governmental policy action. So watch out for the CAD very closely because that is really the key thing.
Clearly inflation is moderating; growth is moderating so we are in a lower rate trajectory. So, how much they will cut over a period of time, I am not really sure.
If the CAD really continues to be worse and the currency comes under pressure. There would be chances of an open market operation (OMO) by the government because liquidity infusion required because of currency intervention that could be a positive for a bond market in the longer tenure bonds specifically.
Otherwise if things stabilize and if the CAD does not become a stress then we are looking at steepening on the yield curve simply because growth is going to be lower, fiscal is going to look a little worse than what we expect now. One should be looking at the yields on the 10-year actually moving up from these levels.
Q: The reason why I want to prod further on how you see bond yields moving is that there is this held-to-maturity (HTM) pressure, 50 bps of HTM will have to be mark-to-market in the current quarter itself and eventually in four quarters it comes down to 23, there is of course OMO available, but therefore in the next eight weeks do you see yields hardening in the next eight weeks or do you think there could be some softening?
Vaidya: It depends on what we are talking about. If we are talking about 10-year bonds, the yields can harden a little bit and they can move up by about 5-10 bps. The demand from the banks which typically house a lot of HTM will obviously be lower. The month of May is packed with full supply, so I think I would still put the current 8.15 percent benchmark anyway trading between 7.75 percent to 7.90 percent range.
Clearly, there will be an upside risk in terms of moving upto 7.90 percent range, but the new benchmark if at all it comes, in the next 15-20 days or whatever timeframe this month, then that can be about 10 bps lower. It also depends upon what you are really looking at.
Q: Do you see people now starting to lower their GDP forecast for FY14?
Chakrabarty: It is the central bank’s job to be somewhat pessimistic and the government’s job to be somewhat optimistic. So in that sense we are fine that we are right now sitting just on the middle of both these range of forecasts. We are at 6 percent. For the time being we will hold onto our view.
The market is in the range provided by the central bank on one extreme and the government in another extreme. So I do not think there will be a hurry to revise down growth forecast. A lot will depend upon government action and global developments if on both sides we start getting good news then I am sure that RBI will not be averse to raising its own growth forecast as the year progresses.
Q: So your overall comment on the current policy would be that it is pessimistic not realistic?
Chakrabarty: I am saying RBI is sounding cautious. We have got three years of set of severe challenges. We are just seeing probably light at the end of the tunnel. It is not the time to suddenly turn radical and say that all our problems are over.
It is just taking time and it is a kind of sobering thought for the market not letting market optimism completely go on a high. That is why for a very definite purpose RBI is sounding more cautious than it would have otherwise done.