Economy: Higher probability now for a July pause :: Kotak Sec

Economy: Higher probability now for a July pause
` RBI keeps the policy status quo...
` ...despite most of domestic factors supporting an easing
` External sector developments seem to have led to the decision to pause
` Probability of a July pause has increased

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Economy
Higher probability now for a July pause. The RBI has kept repo rate and CRR
unchanged and provided adequate caution for monetary easing going ahead. For the
RBI, (1) the external sector vulnerability owing to global uncertainty and (2) the inflation
risks, especially food, and pass-through of INR depreciation seem to have tilted its decision
in favor of a pause. Important to note is the guidance that “only durable receding” of
inflation will condition RBI’s next move. Based on the understanding of the current
situation, we feel that probability of a rate cut in July has also receded to a large extent.

RBI keeps the policy status quo…
The RBI has kept the policy repo rate unchanged at 7.25%, putting more emphasis on the potential
risks emanating from the balance of payment owing to the recent global financial market volatility.
The CRR was also kept unchanged at 4% of NDTL on the belief that net LAF has remained near the
comfort zone lately. This reflects the impact of primary liquidity injection in the past months in the
form of CRR cut, OMOs, and significant reduction in Government’s cash balances with the RBI.
… despite most of domestic factors supporting an easing
As per the communication on Monday, the RBI highlighted significant amount of positives that are
likely to have supported our call for a 25 bps cut in this policy. RBI pointed out that (1) macro
conditions are weak, domestic demand is lackluster and investment sentiment remains subdued,
(2) inflation moderated as projected including a softer bias to the non-food manufactured product
inflation, (3) fiscal is more comfortable and (4) the festival related/seasonal gold import seems to be
softening in June. The policy-led efforts to reduce gold imports and softer global commodity prices
are likely to lead to some moderation in the CAD.
External sector developments seem to have led to the decision to pause
The policy decision was clearly influenced by the recent INR depreciation and its likely pass-through
implications for domestic inflation. Moreover, the RBI remains cognizant of the risks to further
depreciation pressures on the INR due to apprehensions of possible tapering of Fed’s QE. Given
that a large part of FII outflows lately have been from the debt side, any rate cut would have made
it less lucrative for foreign investors to hold INR assets. For the RBI, despite a softening bias to the
CAD, the near-term challenges to finance the lower CAD through ’stable‘ capital flows remain.
Even as the RBI acknowledged the consistent easing of headline WPI inflation for the past three
months, it remains wary of the high and sticky food inflation, particularly cereals and vegetables.
For the RBI, “the inflation outlook will be influenced by concerted efforts to break food inflation
persistence”. The risks to inflation further arise from the release of suppressed inflation, rise in
MSPs as also the INR depreciation.
Probability of a July pause has increased
The key for us is the RBI’s statement that “only a durable receding of inflation” will open up space
for further monetary easing. Our estimate of the inflation trajectory indicates that we are not likely
to see significant inflation dips immediately. Especially on the core WPI inflation, the currency
depreciation bias could even lead to a moderate uptick. Apart from this, we believe that external
sector vulnerability is the over-riding burden for the RBI right now. The RBI would remain wary of
the global uncertainty and potential spillovers on India. Unsurprisingly, the policy focus is now
extended to the balance of payments, implying that risks to finance the CAD (and hence currency
depreciation) are becoming increasingly important along with the CAD. On the back of this, we
now see a heightened chance for the RBI to stay on pause in the July policy meeting and also
believe that the chances of an extended pause have likely increased.