RBI chimed a relatively hawkish note following its latest policy review, underscoring our view that, while a final 25bps rate cut this cycle may yet be eked out, the end of the rate cutting cycle is now in sight.
Both governor Raghuram Rajan, in his press conference, and the accompanying policy statement noted that the central bank is looking for ‘space’ or ‘scope’ to ease policy further, there is currently no room for further policy accommodation.
Two key factors are the inflation outlook and the evolution of RBI’s projection for CPI early next year. RBI’s modal expectation remains for inflation to hit its 5% interim target, but it sees the risks around the central tendency as more to the upside than it anticipated six weeks ago. Two factors have been vital. First, the continued rebound in international prices will add more zip to inflation over the next year or so if current levels are sustained.
Our base case forecasts see around 70bps added to y-o-y CPI inflation by Q1 next year from higher oil prices. RBI’s forecasts are presumably similar.
Second, April’s CPI report showed more inflationary pressure than expected, meaning that the starting base for the latest forecast is somewhat worse. April CPI was disappointing on two fronts — a number of food items, not least pulses, surprised to the upside, while ‘core’ inflation gauges ticked modestly higher or were sticky.
As we had emphasised in our pre-meeting commentary, the capacity for a further rate cut in H2 largely hinges on the progress of this year’s monsoon.
If forecasts for a normal, even abundant monsoon are correct and the temporal and spatial distribution of the rains is also favourable, food inflation (39.1% of the CPI basket) should pull back sufficiently to broadly offset the upside risks flowing from oil, reviving domestic demand and the lurking impact of the yet-to-be-implemented 7th Pay Commission.