India: RBI stands pat; maintains accommodative stance :: Nomura Research

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 The RBI kept its repo rate at 7.50%, in line with expectations and because of lack of

transmission by banks and risks to inflation due to weather disturbances.

 The RBI expects real GDP growth to rise to 7.8% y-o-y in FY16 and 8.1% in FY17,

from 7.5% in FY15. It expects CPI inflation to remain below 6% in FY16, hovering

around 5% during Apr-Sep and above 5.5% during Oct-Mar.

 That said, the central bank compensated for the lack of action on monetary policy

front with some regulatory reforms on the banking and financial markets side.

 The forward guidance indicates that the “accommodative stance of monetary policy

will be maintained” and conditioned on incoming data including: 1) transmission by

banks; 2) food inflation trends; 3) further supply-side measures of the government;

and 4) US monetary policy.

 In our view, the bulk of the disinflation is already behind us. With inflation likely to

stabilise around 5-5.5%, the output gap likely to close in the next year and the RBI

targeting 4% inflation in the medium term, scope for further easing is limited as

current policy rates at 7.50% (our baseline terminal forecast) are already close to

neutral.

 Having said that, we are cognisant that the RBI’s policy stance remains

accommodative, and therefore, we continue to see a risk of a final 25bp repo rate

cut most likely in June, provided the upside risks to inflation due to unseasonal rains

do not materialise. After this, we expect the RBI’s policy stance to turn neutral.

 Rates strategy: We believe today's policy announcement should push back any

front-loading of rate cut expectations and should help flatten the swap curve. On

bonds, we remain constructive given improved liquidity and lower net supply in

H1FY16.

 FX strategy: We see some positives from RBI Governor Rajan’s post-meeting

comments and continue to expect INR outperformance against the NDF and within

the Asia region.

The Reserve Bank of India (RBI) left its repo rate unchanged at 7.50%, in line with

expectations (Nomura and Consensus: 7.50%). The RBI also left the cash reserve ratio

(CRR) unchanged at 4.00% and the statutory liquidity ratio (SLR) unchanged at 21.5%.

The RBI stood pat because lack of transmission by banks (lower lending rates) and risks

to inflation due to unseasonal rains and the monsoon outturn argued for maintaining the

status quo at the current juncture.

Gradual growth recovery, stable inflation

The RBI expects improved financial conditions, government efforts to kick start

investment, the lower and stable inflation outlook and higher profit margins to support a

gradual growth recovery. The RBI expects real GDP growth to rise marginally to 7.8% y-
o-y in FY16, and further to 8.1% in FY17, from 7.5% in FY15 but with downside risks

(Figure 1). While the RBI expects growth to improve, it found the new GDP data puzzling

as they do not square with still-subdued real activity indicators and corporate earnings.

As such, the RBI expects FY15 advance estimates to be revised down (which, in turn,

could add upside to its FY16 estimates).

Meanwhile, the RBI expects CPI inflation to remain below 6% in FY16, hovering around

5% during Apr-Sep and above 5.5% during Oct-Mar. More specifically, the RBI expects

CPI inflation to fall to around 4% by August 2015 before firming up to 5.8% by March

2016 (Figure 2) with risks to inflation largely balanced. Looking ahead, the RBI’s
medium-term models suggest CPI inflation should be 5% by Q1 2017, and the RBI re-
iterated its commitment to lowering CPI inflation to 4% by Q1 2018.

Overall, the RBI expects a gradual growth recovery and inflation to stabilise around 5.0-

5.5% in the next two years.

Focus on regulatory and other measures

The RBI compensated for the lack of action on monetary policy front with some

regulatory reforms on the banking and financial markets side. It allowed commercial

banks to invest in infrastructure bonds of rival banks (cross holding) to boost

infrastructure lending. Further, in order to boost transmission of monetary policy, the RBI

stated that it will encourage banks to move to marginal-cost-of-funds-based

determination of their base rate. Elsewhere, the RBI proposed allowing Indian

companies to raise external commercial borrowings through issuance of INR bonds.

A conditional accommodative forward guidance

The RBI’s forward guidance states the “accommodative stance of monetary policy will be

maintained.” However, the forward guidance was conditioned on incoming data

including:

1. Sign of transmission by banks of the 50bp repo rate cut delivered thus far.

2. The outlook for food inflation given risk of unseasonal rains and monsoon

outturn, although the RBI will look through both base and seasonal effects on

inflation.

3. Government policy efforts to unclog the supply response, high quality fiscal

consolidation and debottlenecking of stalled investment projects.

4. Signs of normalisation of US monetary policy.