Don’t Expect a Rate Cut: RBI may await for the Budget

Moneylife Digital Team 01 February 2016

The central bank is likely to monitor the targets and consider the rationale of any adjustments and thus would wait for the signals from the Budget, says DBS report

The Reserve Bank of India, which will announce its monetary policy on Tuesday, is most likely to keep the key rates on hold. "After 125 basis points (bps) worth rate cuts in 2015, the benchmark repo rate is likely to be held at 6.75% and reverse repo at 5.75%. Reserve ratios will be left unchanged, we reckon. We see room for a 25bps cut in March or April if the FY16-17 Budget satisfies the central bank on the government’s fiscal consolidation efforts," says DBS Bank Ltd in a report.

According to the research report, although the inflation is still within the RBI's January 2016 target, it faces risks, like the implementation of the Pay Commission's proposals. CPI inflation numbers have been inching up since third quarter of 2015. From a low of 3.9% in the September quarter, inflation rose to more than a year’s high at 5.6% by December. Core inflation, while still benign, has also tracked the uptrend. Other price indicators, for instance WPI inflation and PMI sub-indices are also off recent lows. The disinflationary impact of low crude prices was more than offset by a sharp jump in food price pressures and was not helped by adverse base effects. Service sector inflation remains sticky and indeed rose to 4% from 3.1% in the September quarter.

It said, "Despite the recent increase, the inflation outlook appears manageable. The RBI’s inflation target of 6% for January 2016 is unlikely to be breached. Excess capacity in the economy and slower turnaround in demand indicators suggest core inflation is likely to stabilise around 5% in the March 2016 quarter. Inflationary expectations are elevated but low oil prices are likely to temper a renewed climb in the indicators. We expect FY15-16 CPI inflation to average 5%, which will rise to 5.4% in FY16/17. The price trend thus is benign compared to historical trends, but expected to stay modestly above target the RBI’s 5% target for next year."

"The elephant in the room is the Pay Commission proposals," DBS said adding, "If the Panel’s recommendations are adopted at the FY16-17 Budget, there will be a temporary spike in prices when the increment kicks-in this year. Of concern particularly are the 140% increase in the housing allowance and potential second-order impact from higher public-sector wages, which we estimate could lift annual inflation by 100bps above the RBI’s 5% target for March 2017. The impact would be muted if wage increases were staggered or partly deferred to the next year."

According to DBS, the Budget 2016-17 would be a key factor to watch. After meeting this year’s goals, the government’s commitment to fiscal discipline will be put to test in FY16-17. Any signs of a delay in fiscal consolidation efforts would be seen as inflationary, it said.

Last year the RBI lowered repo rate by 25bps soon after the FY15-16 Budget, even though the deficit target had been adjusted higher. This was seen as an immediate endorsement of the government’s move to rationalise subsidies and re-channel savings towards higher capital expenditure.

"This time, the central bank is likely to monitor the targets and consider the rationale of any adjustments. If the additional fiscal room (higher deficit) is channelled towards higher capex spending and improvement in revenue collections, the RBI would likely take a favourable view. In the event, the RBI is likely to await the budget announcement before taking further action," DBS said.

According to the research note, the need of the hour for the government is to strike a balance between, fresh spending commitments, a pro-growth stance and compensation for low tax buoyancy or disinvestment proceeds. However, a deficit target higher than 3.5% of GDP target could be adopted for FY16-17, just as the windfall from low commodity prices fades, DBS added.

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