Oct 04, 2016 03:23 PM IST | Source: CNBC

RBI expected to hold rates at Patel's first meeting as governor

A Reuters poll found the majority of market watchers expected the RBI to keep its policy repo rate - the rate at which it lends to banks - at 6.50 percent, but many expected a 25-basis-point cut by end-December.

The Reserve Bank of India (RBI), led by new governor Urjit Patel, is expected to keep rates unchanged on Tuesday, but with the prospect of a move later this year.

A Reuters poll found the majority of market watchers expected the RBI to keep its policy repo rate - the rate at which it lends to banks - at 6.50 percent, but many expected a 25-basis-point cut by end-December.

It will be the central bank's first monetary policy decision under Patel, the former deputy governor who took over from Raghuram Rajan in September.

"I would expect, given the fact that he's a new man on the job, [keeping rates] unchanged is the most likely option," Richard Titherington, CIO and head of emerging markets and Asia Pacific equities at JPMorgan Asset Management, told CNBC's "Squawk Box" on Tuesday. "Continuity is the watch word in the RBI at the moment."

While the consensus is for Patel to stand pat on rates, government data released in September showed August prices in India were relatively stable, and in line with the RBI's target of hitting 5 percent inflation by March 2017, which suggested there was room for rate cuts.

Consumer price inflation in India eased to 5.05 percent on-year in August, compared to July's 6.07 percent, on the back of slower rises in food prices. Wholesale prices in August rose 3.74 percent on-year, which was lower than the 4.01 percent annual rise predicted by economists in a Reuters poll, but a touch higher than July's read of 3.55 percent.

Analysts at Bank of America Merrill Lynch (BoFAML) said in a Tuesday note that a good monsoon season meant prices were expected to drop further. They expect consumer price inflation to come in at 4.3 percent on-year in September.

But some said the August consumer inflation print was still too high for the RBI's longer-term inflation target of 4 percent, with a 2 percent range on either side.

"While CPI has eased back substantially towards 5 percent in August, it was perilously challenging the upper bounds of [the RBI's long-term] inflation targets," Vishnu Varathan, a senior economist at Mizuho Bank, in a Monday note.

In the interest of policy credibility and macro economic stability, however, Varathan expected Governor Patel to stand pat on rates.

Alicia Herrero, chief economist for Asia Pacific at Natixis, agreed that the new governor "should have every incentive to err on the [side of] caution" by keeping rates steady on Tuesday.

In a world where the U.S. Federal Reserve was gradually normalizing interest rates, Herrero said that the risk a rate cut would slow capital flows to India - which is currently the fastest growing major economy in the world - would not be significant as long as yield curves in the U.S. did not steepen too quickly.

"India is still among the highest yield options around," she said.

JPMorgan's Titherington added that the RBI had room to cut rates further because like many central banks, the relative weakness of the greenback gave it greater flexibility.

Cutting interest rates usually weakens the underlying currency, but the currently weaker dollar means the domestic currency would likely remain relatively stronger against the greenback.

The Indian rupee traded at levels above 68.00 against the dollar in February but has since strengthened to more recently trade slightly above 66.00. On Tuesday morning, the dollar/rupee traded at 66.47.

Going against consensus, the BoFAML analysts expect a 25 basis points repo rate cut to 6.25 percent from the RBI on Tuesday and a total reduction of 50 basis points by March 2017.

The analysts said a rate cut from the RBI would support the rupee in case of a "global risk off at a time of weak seasonality and maturity of $26 billion of 2013's foreign currency non resident deposits."

Three years ago, India introduced a program to regain foreign investor confidence by offering dollar deposits to non-resident Indians, using what was known as foreign currency non-resident deposits.

A rate cut would also signal for banks to lower their lending rates before credit demand picked up during the "busy" October-March industrial season. "Real lending rates, at a 20-year peak, are delaying recovery," the BoFAML analysts said.

Tuesday could mark the first meeting of the six-member Monetary Policy Committee (MPC), comprising three RBI members and three external members appointed by the government.

On September 29, the Indian government announced the appointments to the MPC of Chetan Ghate, professor at the Indian Statistical Institute, Ravindra Dholakia, professor at the Indian Institute of Management in Ahmadabad, and Pami Dua, professor at the Delhi School of Economics. Patel and senior RBI officials R Gandhi and Michael Patra comprise the rest of the panel.

It was not immediately clear if the MPC would be involved in Tuesday's decision making process, but local media reports suggested Tuesday would be the MPC's first meeting.

The MPC effectively gives the government a voice in central bank decision-making. Each member is entitled to a vote on policy direction, with Patel getting a tie-breaker vote if necessary. Previously, the central bank governor alone took independent policy decisions.

The MPC's task, as specified by the government's amended RBI Act, was "maintaining price stability, while keeping in mind the objective of growth."

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