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RBI likely to cut rates in early March – Deutsche Bank

Deutsche Bank said it is likely that the Reserve Bank of India would next cut policy interest rates in early March, and follow that up with more cuts through this year. It also said it was looking at the revised GDP numbers with “some degree of caution”.

“The RBI will not only cut in early-March, in our view, but more cuts await in the first half of this year,” said the Bank in a note.

It, however, said further cuts would depend on inflation readings, to an extent.

“Assuming inflation tracks around 5-6% for the rest of the year, the central bank would be comfortable taking the repo rate down to 7%, in our view. This would imply a real repo rate of around 1%.

“Recent deliberations from the RBI suggest the central bank would not want real rates to be any lower than that while it attempts to anchor inflation expectation. Even if inflation were to be somewhat lower, i.e. real rates turned out to be 1.5-2%, we don’t think the central bank would feel compelled to bring the repo rate below 7%.”

India-GDP-inflation-2015

“The central bank is keen to see further progress in fiscal consolidation and capital spending, which it seems necessary to lower inflation and boost growth. Hence even if growth remained lackluster for the time being, we don’t think the RBI would be emboldened to cut rates by more than 75bps in this cycle. Note that a harder goalpost awaits the monetary authority from next year onward, as an inflation target of around 4% for 2016 and beyond appear to be its preferred target,” it added.

Deutsche Bank said it believes that inflation pressure will remain muted for the course of this year. “It is clear that CPI inflation will remain subdued (below 6%) in 1Q of 2015 and WPI inflation will probably turn negative due to the recent petrol and diesel price cuts.

“Pressure on food prices seem to have also eased considerably, which has been the main driver of inflation in recent years and our daily food price tracker continue to show disinflation in various food items, particularly vegetables.

“Moreover, inflation expectations have moderated considerably and the government has re-affirmed its commitment to meet the FY15 fiscal deficit target of 4.1% of GDP. Conditions for further policy easing to continue are firmly in place, in our view.”

GDP RECALCULATIONS

The Bank also commented on the changes in calculating India’s GDP.

Newly released national accounts data by the Central Statistical Organization, revising the base year from FY04/05 to FY11/12, have managed to keep nominal GDP nearly unchanged while changed the composition of growth quite strikingly, it noted.

“We are looking at the new estimate of 6.9%yoy growth in FY13/14 with some degree of caution. The new estimates suggest that the Indian economy is growing above its potential rate (estimated to be around 6.5%), whereas the opposite is considered to be the case in the official circle and the analyst community.”

According to the new numbers, India’s real GDP grew by 6.9% yoy in FY13/14, accelerating from 5.1% yoy growth in FY12/13. This is in contrast to the old figures, according to which real GDP growth was only 5.0%yoy in FY14 (up marginally from 4.7%yoy in FY13).

“All key components of growth are estimated to be higher under the new estimates. Most strikingly, investment is estimated to have grown by 3%yoy in FY13/14 (-0.1% in the previous estimate), while imports of goods and services are estimated to have declined by 8.4%yoy (-2.5%).”

“A shift in GDP computation from factor cost to basic prices has led to major changes in some components of GDP. Growth in “trade, repair, hotels and restaurants” is estimated to have been a robust 13.0%yoy, in contrast to the old estimate of 3.0% in FY13/14. Mining and manufacturing, which is widely understood to be stagnant or declining, has turned out to have grown by a healthy yoy rate of 5.5% and 5.3%, respectively, in FY13/14. Overall, industrial sector GDP growth is reported to be up 5.1%yoy in FY14 in the revised series (as against -0.1% in the old series), which is in stark contrast to the annual industrial production growth average of -0.1%yoy during the corresponding period,” it said.

However, it also added that at least some of the new numbers are in contrast to other data.

“The acceleration in investment growth during FY14 (3.0%yoy vs. -0.3% in FY13) does not corroborate with firm level data (CMIE capex database) which show that the stalled projects were at a record high in FY14. Same can be said about the readings from PMIs. These changes are bound to cause some confusion about the true state of the economy,” it added.

“Evidence at the ground level (i.e. sales and earnings data from corporates) and other high frequency macro indicators continue to indicate that the economy is yet to see a capex recovery and meaningful pick-up in activities.

“Accordingly, we think it will take time for the new national accounts data to gain credibility for policy formulation. Till that time, we think that the RBI will continue to ascertain the underlying strength of the economy by looking at multiple high frequency indicators such as PMI, auto sales, credit, industrial production, net exports and firm level capex data.”

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