RBI Monetary Policy: Rate action to stay data-dependent, says Indranil Pan

Pranjul Bhandari, Chief India Economist at HSBC and Sonal Varma, MD & Chief India Economist at Nomura Financial Advisory & Securities feel no change in inflation trajectory outlook by the RBI is a let down. Bhandari believes food inflation will ease off in the coming months due to structural reforms undertaken by certain states. This should pull overall inflation down to average 4.75 percent over next 12 months. After accounting for real interest rate of 1.25 percent on it, there appears scope for another 25 basis points rate cut, she notes. Varma, however, is not as optimistic on the inflation trend and refrains from immediately pencilling in another quarter percent rate cut. "We expected one rate cut of 25 basis points in December and that has already come in," she adds.  Below is the verbatim transcript of Indranil Pan’s interview to Latha Venkatesh and Anuj Singhal on CNBC-TV18.Anuj: From the statement that Latha read out any chances of whether you can infer in terms of the next rate cut?Pan: Definitely the 25 bps rate cut here was more a data dependent 100 bps drop in the inflation that we saw which brought into focus very sharply the five percent that we were looking at by March 2017. So, that is the reason possibly why the monetary policy committee felt that there could be a possibility of a slight easing in terms of the monetary stance of the Reserve Bank of India (RBI). Very importantly they have maintained the accommodative stance which necessarily means that they would be remaining open to further rate cuts but only if data supports them. And very clearly they continue to be sort of worried about how inflation trajectories might actually pan out.Latha: I just wanted to know from the words that I read out. First it only says that the decision of MPC is consistent with an accommodative stance of the monetary policy in consonance with the objective of attaining five percent. So, it is not really very clear that the future stance also will be accommodative, it says the current cut is in consonance with the accommodative stance and plus in terms of an outlook the committee took note of a potential cost pressures from the seventh pay commission. Is it giving you a sense of another cut?Pan: The way I would put it is that it would continue to be data dependent, number one. Number two, a lot of global factors also are involved in how your own data on inflation actually reacts. The oil and US elections and the Fed action will be important. So, I would continue to hope for another 25 bps cut if more or less your pulses prices, vegetable prices etc continue to be sort of contained in the near future.Anuj: You heard the governor, you read the MPC statement. What are you taking away in terms of future action expectation?Bhandari: This is definitely what I will call a cautious cut, the fact that they cut rates but they also did not change the inflation trajectory. This come as a big surprise to me because if you really look at, if you are following the daily food data and all that we get it seems quite likely that overall inflation will be less than five percent in the first quarter of 2017. So, the fact that they stuck to five percent and they actually highlighted upside risks still despite in their own qualitative assessments saying that a lot of good things are happening on sowing this seems a little inconsistent to me. My own view here is that in the next few months we will see food inflation fall quite dramatically. We expect that over the next 12 months inflation will be averaging closer to 4.75 percent and if you add to it the real rate of 1.25 percent which Mr Michael Patra was talking about that gives you a equilibrium repo rate of six percent which basically means that 25 bps rate cut is still on the cards which currently the Reserve Bank of India is not really putting in paper.Latha: You said you are still pencilling in a quarter percent. Any other key takeaways from the governor\\'s press conference and what in your view would be the likely bond rates, by March 31, or December 31?Bhandari: Expecting a 25 bps rate cut which we think is left in the cycle and I am saying that because of forecast for inflation in the next 12 months is 4.75 percent lower than the five percent target that the RBI has. Some good reasons to think why it should be lower than that. The fall that we have seen in food prices is not all seasonal. There is also some structure element to it. Just this year Maharashtra has done some big reforms in bringing out fresh foods from APMC. Karnataka has been doing structural reforms in the last two years on e-markets. If you actually look at food inflation of these states they have come down dramatically. All of these adds up to something.It is not likely that food inflation will rise up in these states in the next couple of months. Also the food inflating has a huge impact. Directly it impacts about 45 percent of the consumer price index (CPI) basket but though the inflation expectations channel we actually calculate that it might be impacting closer to 60 percent of the CPI basket. So, if food prices are going to be low for at least the next couple of months then we can see a fall in headline inflation which can be durable and a 4.75 percent average inflation married that with Dr. Michael Patra\\'s 1.25 percent real rate math and you get repo rate at six percent which basically means one more 25 bps rate cut is out there right now.Latha: You heard the press conference I assume and saw the committee’s statement it looks like there is space for more?Varma: Well, there is no forward guidance here and what was surprising is that the inflation outlook hasn’t really changed from the previous policy growth is still at 7.6 percent, inflation is still at 5 percent with upside risks, so the reduction in policy rate has come in not because the inflation outlook has changed, the framework itself is getting tweaked.Under the previous Governor it was very clear that they wanted to get to 4 percent by March 2018, I don’t think there is clarity now whether that midpoint target by March 2018 is still there. It seems to be more 2-6 percent range over next 5 years which is quite wide and second as they mentioned in the media call the real rate from 1.5-2 percent has been brought down to 1.25 percent for now, so if the policy action is being driven not by inflation outlook changing, but by framework getting tweaked then it suggest that there is some change, even though the flexible inflation targeting framework is here to stay etc, but within the framework there are tweaks that are being made.Latha: So you would pencil in for the cuts?Varma: Well, as of now we don’t have a cut pencilled in, if the framework is tweaked further to accommodate a cut of course it’s possible, but as of now we don’t have a cut pencilled in. We had a cut for December which has come in, so as of now we don’t have a cut pencilled in.Latha: You said you are still pencilling in a quarter percent. Any other key takeaways from the governor's press conference and what in your view would be the likely bond rates, by March 31, or December 31?Bhandari: Expecting a 25 bps rate cut which we think is left in the cycle and I am saying that because of forecast for inflation in the next 12 months is 4.75 percent lower than the five percent target that the RBI has. Some good reasons to think why it should be lower than that. The fall that we have seen in food prices is not all seasonal. There is also some structure element to it. Just this year Maharashtra has done some big reforms in bringing out fresh foods from APMC. Karnataka has been doing structural reforms in the last two years on e-markets. If you actually look at food inflation of these states they have come down dramatically. All of these adds up to something.It is not likely that food inflation will rise up in these states in the next couple of months. Also the food inflating has a huge impact. Directly it impacts about 45 percent of the consumer price index (CPI) basket but though the inflation expectations channel we actually calculate that it might be impacting closer to 60 percent of the CPI basket. So, if food prices are going to be low for at least the next couple of months then we can see a fall in headline inflation which can be durable and a 4.75 percent average inflation married that with Dr. Michael Patra's 1.25 percent real rate math and you get repo rate at six percent which basically means one more 25 bps rate cut is out there right now.