RBI’s easing cycle is not over yet - Capital Economics
India Economics

RBI’s easing cycle is not over yet

India Economics Update
Written by Shilan Shah
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It came as no surprise that the new MPC voted unanimously to keep the repo and reverse repo rates on hold today. But the relatively dovish tone of the statement, along with the dire growth outlook, mean we remain comfortable with our non-consensus view that the easing cycle will resume before long.

  • It came as no surprise that the new MPC voted unanimously to keep the repo and reverse repo rates on hold today. But the relatively dovish tone of the statement, along with the dire growth outlook, mean we remain comfortable with our non-consensus view that the easing cycle will resume before long.
  • Today’s announcement was in lieu of last week’s postponed meeting after the government failed to appoint new MPC members in time. Since then, Ashima Goyal, Jayanth R Varma and Shashanka Bhide have been selected for the committee. (See here.) In the event, the MPC unsurprisingly voted to keep the repo and reverse repo rates unchanged, at 4.00% and 3.35% respectively. The cash reserve ratio remains at 3.00%, while the marginal standing facility rate also remains unchanged at 4.25%.
  • The main reason for policy inaction today was the stickiness of inflation. Headline CPI inflation has risen from 5.8% y/y in March to 6.7% y/y in August and is likely to have edged up further in September (the data are due on Monday). Governor Shaktikanta Das stated in the press conference that “COVID-19-related supply disruptions, including labour shortages and high transportation costs, could continue to impose cost-push pressures”.
  • Further ahead however, our view is that core inflation will drop as some of the supply chain problems are resolved and the collapse in demand more than offsets supply constraints. (See Chart 1 and our Update, “Inflation close to peaking”, 2nd September.) This view appears to be shared by the MPC, which took a more dovish tone in today’s policy statement compared to the previous one in August. It noted today that “the underlying factors [that are driving inflation] are essentially supply shocks which should dissipate over the ensuing months”.
  • All of this links to a broader point about the need for further policy loosening: the dire outlook for the economy. Indian GDP shrank by almost a quarter in Q2. That will have marked the bottom, but the still-rapid spread of the virus and the need for prolonged containment measures will continue to dampen domestic demand. The RBI today provided a growth forecast for this fiscal year for the first time since the start of the pandemic – it thinks the economy will shrink by 9.5% in FY20/21. We wouldn’t dwell too much on small differences between forecasts given the scale of the shock but this would almost certainly be one of the largest slumps anywhere in the world.
  • All of this augurs for further policy loosening. Indeed, the RBI has maintained its “accommodative” policy stance and Governor Das stated that “that revival of the economy… assumes the highest priority in the conduct of monetary policy”.
  • Given that statement, we are comfortable with our view that the easing cycle – the repo and reverse repo rates have already been cut by 115bp and 155bp this year – has further to run. Our forecast is for a 25bp rate cut in December, though there is clearly a chance that it gets delayed until February if the drop in inflation is slower than we currently anticipate. In total, we are forecasting another 50bp of cuts in this cycle. (See Chart 2.) Our policy rate forecasts are currently more dovish than the view priced into markets.

Chart 1: Consumer Prices (% y/y)

Chart 2: Repo Rate (%)

Sources: CEIC, Capital Economics

Sources: CEIC, Capital Economics


Shilan Shah, Senior India Economist, Shilan.Shah@capitaleconomics.com