By Indranil Sen Gupta & Aastha Gudwani
We grow more confident of our expectation of the RBI MPC cutting 75bp in 2020 after February CPI inflation came off its earlier peak to 6.6% (7% BofAe, 6.7% consensus) from January’s 7.6%. With growth weakening on high real lending rates and falling global growth, we expect it to cut rates by 25bp by April 3. Our US economists see the Fed cutting 100bp by April. We see a further cut in June as inflation will likely fall to the RBI’s 2-6% range and the March quarter growth post a weak 4.3%. We expect a final 25bp RBI rate cut in October with inflation set to fall to 2.5% in October-March and the ‘busy’ industrial season starts. To pull down lending rates further (50bp in FY21 BofAe), we expect the RBI to infuse $45bn of durable liquidity in FY21 on top of $73.5bn FYTD (vs $40bn BofAe).
Inflation peaked: 6.6% Feb, 5.8% March, 3.6% core
As expected, inflation has come off its peak, easing to 6.6% in February from 7.6% last month. Core inflation remains well contained at 3.6%. We track 5.8% in March with onion prices coming off further, partial roll back of Liquefied petroleum gas (LPG) price increase and falling petrol prices.
Lower oil prices reduce inflation: We have cut average FY21 inflation by 20bp to 4% from 4.8% in FY20 with our oil strategists cutting their FY21 forecast to $45/bbl. A 10% drop in oil prices should lower consumer price index inflation by 23bp directly and 100bp over time.
RBI to cut 75bp in 2020: 25bp each by April 3, June, October
We expect the RBI MPC to cut rates by 25bp before or on April 3 with inflation having peaked, global growing slowing (to 2.2% in 2020 BofAe from 3.1% in 2019) and our US economists expecting the FOMC to cut 50bp each on March 18 and April. An immediate RBI rate cut will lower lending rates for banks’ MSME/retail/ mortgage loans before the ‘busy’ industrial season ends in March. We see a compelling case for the RBI MPC to cut rates by 25bp in June with inflation, easing to the RBI’s 2-6% inflation range. March quarter growth should post an anemic 4.3%, with downside risks. We expect the RBI MPC to cut by 25bp for a third time in October. Base effects and weak demand will likely drag inflation down to an average 2.5% in October-March. Second, this will signal lower lending rates on the anvil of the next ‘busy’ industrial season. Finally, the RBI’s revised ‘flexible’ inflation targeting framework will likely introduce growth and financial stability as co-objectives of monetary policy along with price stability.
Fundamental drivers of inflation remain weak
Weak growth: We expect India to grow by 4.8% in FY20 and 5.4% in FY21. January IIP growth was a weak 2%. Our India Activity indicator points to a long bottom.
Tight M3 liquidity: We still see marginal excess M3 demand at 0.1%.
Higher rabi harvest to contain agflation: Winter rabi sowing is up 9.5%.
Low ‘imported’ inflation: Our oil strategists have cut Brent prices to $45/bbl in FY21 (from $63/bbl in FY20). The RBI’s $51bn FX intervention should contain depreciation. April – December 2019 CAD, at 1% of GDP should also support rupee.
Limited fiscal slippage: We see 30bp upside risk to the Center’s fiscal deficit target of 3.5% of GDP for FY21 BofAe. This is still well below the 4.5% long-run average.
Edited excerpts from BofAML’s
India Economic Watch report, dated March 12, 2020
Sen Gupta is chief India economist and Gudwani, India economist. DSP Merrill Lynch (India)