Economy: Rate easing on way :: Kotak Sec,report

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Rate easing on way. The sustained disinflation momentum, reinforced by the recent
December CPI and WPI trends, prompted the RBI to start the easing cycle earlier than
expected. We retain our call that that there will be further scope for monetary
accommodation of another 50-75 bps for the rest of CY2015. We expect the next cut
of 25 bps to come in early March post the Union Budget and see a decline for the
benchmark 10-year G-Sec yield ranging at 7.25-7.60% for FY2016.

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RBI’s surprise rate cut hinges on comfortable inflation momentum
Surprising the Street, the RBI on Thursday cut the policy repo rate by 25 bps to 7.75%, before
the scheduled policy meeting on February 3. In our post-December policy review note RBI
policy: preparing for rate cuts, we had indicated that by opting for out-of-the policy option, the
RBI “effectively opens up the timing of the first rate cut to a wide window of mid-January (after
December inflation release) and early-April (scheduled policy meeting)”.
The RBI hinged the rate cut on (1) sharper-than-expected easing in headline inflation, partly
helped by sharper correction in vegetables and fruits prices and ebbing cereal inflation,
(2) subdued global commodities and their price outlook, particularly that of oil, and (3) the
government reiterating its desire to stick to its fiscal targets. Additionally, the muted demandside
pressures have meant that core inflation momentum remained subdued while households’
near-term and long-term inflation expectations have adapted (the outcome of the latest
inflation expectations survey from the RBI is still not public).
More to come—pace will be measured
The December CPI inflation was crucial as it was the first print sans the favorable base effect.
Further, the pick-up in the December headline WPI inflation was more muted than expected,
explicitly due to the broad global disinflationary trend. Consequent to the December prints of
the retail and wholesale inflation, our inflation model predicts an average CPI inflation for
FY2016 at 5.6% while for January 2016 is just about 6%. We had also indicated in our note
Further comfort on disinflationary process on January 14 that “currently downside risks to the
CPI are probably more than the upside risks”.
However, even as the disinflationary process is strongly in place, the RBI in its communication
on Thursday is candid of the fact that it would still need to see (1) sustained high quality fiscal
consolidation and (2) policy response to overcome supply-side constraints, to improve the
potential output in order to ensure a non-inflationary growth. In this context the depths of the
cut are likely at a maximum of 100 bps (including Thursday’s 25 bps cut). We see the next 25
bps easing only in early March after the Union Budget, following which the scheduled April
policy date is expected to be skipped in favor of June (third cut of 25 bps).
Bonds shift lower, to end March at 7.50%
10-year benchmark G-Sec yield has fallen by ~10 bps from Wednesday’s close and expectations
of further rate cuts are bond supportive. Given our expectation for the next 25 bps cut in early
March 2015 and a gross borrowing for FY2016 at ~`6.2 tn, 10-year yield is likely to close at
~7.50% by end-March 2015. Further down, the rally could get restrictive as expectations of
deeper cuts by the RBI end. For FY2016, 10-year yield is likely to range at 7.25-7.60% with
some steepening coming back to the yield curve.

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily16012015kl.pdf