RBI begins its easing cycle

On the morning of 15^th January, 2015, the RBI Governor chose to surprise the market by announcing a cut in interest rates by 0.25%. This pre-emptive announcement was a fortnight ahead of the scheduled policy review meeting, to be held on 3^rd February.

In a move which was against our expectations the RBI reduced the Repo rate by 25 bps to 7.75%, reacting to the lower than expected December inflation numbers, the government’s commitment on this year’s fiscal targets, and the continuing fall in global commodity prices – particularly crude.

We had expected a 50 bps cut immediately post the Budget but the RBI had committed to initiate the process of monetary easing as soon as data indicated that medium term inflationary targets would be met. And thus they have met the commitment with an inter-meeting cut. We now expect a further 25 bps cut in the April policy post a budget outcome.

Inflation projections have fallen significantly below the 8% targeted by January 2015. This is significant, as for the first time RBIs has shown its comfort that it now expects CPI inflation to be below its January 2016 target of 6%.

The RBI Governor Raghuram Rajan re-iterated that “once the monetary policy stance shifts, subsequent policy actions will be consistent with this stance. Key to further easing are data that confirm continuing disinflationary pressures”

This means further rate cuts could be due later in the year and will depend on monsoons and high quality fiscal consolidation as well as steps to overcome supply constraints.

Bond yields had already priced in this 25 bps cut post the soft inflation data. The rate cut on an auspicious day should make the finance ministry very happy and also possibly indicates that the Governor has got comfort from the ministry on fiscal trajectory and on the signing in on the inflation mandate. Also, for a while, it will put to rest the press reports on RBI and ministry not being on the same page.

Given that this is a start of a possibly 12-18 months easing cycle, we should expect banks to start cutting lending rates very soon and support the RBI in monetary transmission.

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