With both retail and wholesale inflation easing, the Reserve Bank may cut policy rates by another 25 basis points this fiscal, India Ratings said.
Retail inflation hit a 13-month low at 4.31 per cent in September as against 5.05 per cent in August, while wholesale inflation too eased to 3.57 per cent from 3.74 per cent in the same period, primarily led by softening food prices.
“The change in the RBI policy stance with respect to the reduction in real interest to 1.25 per cent from the 1.5-2 per cent range coupled with extending the time to achieve 4 per cent inflation by three years (to March 2021 from March 2018) has provided RBI additional space for monetary easing in the near-term,” India Rating said in a report.
The agency expects another 25 basis points cut in the repo rate in the financial year 2016-17.
In the October 4 review, RBI had cut repo rate by 25 basis points to 6.25 per cent, taking the total rate cuts since January 2015 to 175 bps.
The agency expects the easing trend to continue next month as well.
It said lower retail inflation is indeed a reason for cheer, particularly when the festival season is round the corner.
“But there are few pressure points that need attention, such as rising trend in cereal prices, rise in the prices of transport and communication services and the likely impact of house rent allowance as and when announcement on allowance is made by the government.
“The other area of concern with respect to retail inflation is a sustained higher inflation in rural areas than urban areas,” the report noted.
Rural CPI came in at 5 per cent as against 3.6 per cent urban CPI in September.
It said lower inflation cements market expectation of a rate cut and is, therefore, likely to keep bond market sentiment buoyed, with risks emerging from the US Fed rate hike probability and a potential surge in oil price.
While G-secs are likely to remain in focus, preference could shift to highly rated corporate bonds and state development loans as investors rush to capture yields, it said.
The report said in the medium term, the rupee will continue to be supported by fundamental drivers while the short-term movement will be guided by corporate earnings and global risk appetite.
Inflow position has favoured the equity segment over the debt market for most of 2016.
“These flows will be impacted as the Fed moves closer to hiking rates while the concern over almost USD 26 billion FCNR-B deposits redemption will pose volatility risks,” the rating agency said.