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RBI unlikely to continue with rate cuts much longer – Emkay

Pointing to a flattening out of the disinflationary trend, Emkay Global Financial Services said the Reserve Bank of India is unlikely to continue much farther with the ongoing rate-easing cycle.

The RBI cut key interest rates by 25 basis points today – the third such cut this year – as inflation showed signs of easing over the last five months.

However, reading into RBI’s commentary on the current scene, the broker said big cuts are unlikely in the current cycle.

“Based on the inflation and currency volatility concerns, we believe RBI would reduce rates further by only 25bps in this short-lived accommodative cycle,” it said. “We believe, that the is a high probability of RBI pausing in its next policy announcement on 4th August as RBI would await for the outcome of Fed’s possible liftoff in Sep’15 and outturn of the seasonal monsoon before taking any action.”

As expected, the RBI reduced the repo rate by 25bps to 7.25% today, while leaving CRR and SLR unchanged.

“However, rising concerns of premature ending of disinflationary trend and concerns over the growth were clearly highlighted in policy as RBI scaled up the inflation projection to 6.0% by Jan’16 and revised the real GVA growth projection downwards to 7.6% for FY16E from 7.8% estimated earlier. Clearly, this has diminished the hopes of a sustained softening in the interest rate cycle. We believe, RBI will resort to shallow rate easing cycle.

“Any scope for further accommodative response is contingent upon increasing potential growth through investments, rather than inducing countercyclical boost to demand through rate easing, which can aggravate inflation and widen current account deficit.”

Although inflationary concerns over the medium term have actually increased over the last one month, the RBI went ahead with the further easing of the rates by 25bps.

Its rate cut was justified based on the following factors a) deceleration in headline inflation to sub 5.0% in Apr’15, moderate impact of unseasonal rains on inflation and insignificant increase in administered prices b) marginal transmission of rate cuts on lending rates c) postponement of US monetary policy liftoff d) subdued investment and credit growth.

Emkay pointed out that the RBI was cautious but not dovish.

“Contrary to the general view, RBI sounded cautious rather than dovish, notwithstanding the weak growth for two primary reasons a) near term uncertainty and b) limited role of monetary policy in aiding non-inflationary growth, which in turn depends on government policies,” it said.

The brokerage pointed out the following factors as possible causes of worry on the inflation front:

■ Below normal monsoon forecast by IMD pose risk to near term inflation- according to the latest forecast, rainfall is likely to be 88% of the long term average. Food supply management by the government will also be critical in managing the inflation
■ Recent firming up of international crude and metal prices (Exhibit:4)
■ Volatility in external environment, which may lead to sharper weakening of INR/USD and thus result in imported inflation
■ Risk to inflation from an increase in service tax rate to 14%

“Clearly, the inflation trajectory during FY16 is tilted on the higher side as compared to the medium term target of 4% for which sustenance of disinflationary process is essential,” it pointed out.

“Over the medium term this can be attained by reducing supply constraints, higher public investments which can crowed in private sector investments. Most critically, the RBI has linked the attainment of positive supply response to re-capitalisation of PSU banks. While these elements are likely to take time to get established, it does appear that RBI’s gradualist approach jives in well with our view of shallow rate easing cycle.”

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