AXA IM: India frontloading rate cuts to provide a larger support

Aidan Yao, senior Emerging Market economist at AXA Investment Managers (AXA IM), comments on the Reserve Bank of India’s (RBI) recent cut in benchmark interest rate.

The Reserve Bank of India (RBI) today cut the benchmark interest rate by 50bps to 6.75%. While we thought a rate reduction was very likely (for both Sept and Dec), we did not expect the RBI to frontload the rate cuts. Today’s decision was designed to provide a bigger cushion for the economy against the global turmoil and rapidly receding inflation.

Barring substantial further shocks, we now expect the RBI to hold the interest rate for the remaining of this year. Longer-term policy trajectory will be contingent on the central bank achieving its 2016/17 inflation target of 5% – we think the RBI will remain on an easing bias next year. We see today’s rate cut as serving two purposes.

First, it provides a cushion for the domestic economy against the external turmoil. Weakening growth in the global economy, particular emerging markets, coupled with slowing world trade, has taken a severe toll on India’s export growth (down 22% y-o-y in Aug). Sharp declines in exports have a knock-on effect on industries servicing the external sector, creating a sharp contrast with the part of the economy which is domestic-focused, which remains robust. Also mindful of the financial market contagion – India’s SENSEX has fallen by more than 10% since July – the RBI has moved today to offset the downside risks from the external source. Despite this cushion, the RBI has cut the 2015-16 growth forecast to 7.4%, from 7.6% previously.

Second, today’s rate cut was in response to rapidly receding inflation, driven partly by falling global commodity prices and partly by easing food price inflation following a moderate monsoon season. Brent oil prices and the CRB commodity index are between 10% and 12% below the levels at the last bimonthly meeting in early August. The currency depreciation (against the dollar) only trimmed the drop by ~3% in rupee terms. Food price inflation also eased following a tepid monsoon season and proactive responses by the government to mitigate the rainfall deficits in the southwest region. Excluding food and energy, core inflation dropped for the second consecutive month, as falling oil prices start to pass through to lower transportation costs. The RBI cuts its CPI forecast to 5.8% for Jan 2016, a shade below its 6% target.

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