Economy: Rate cut cycle to start soon :: Kotak Securities

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Economy: Rate cut cycle to start soon
 Another good month for CPI inflation
 Core inflation drops
 November IIP shows signs of a pick-up
 RBI likely to start the rate cut cycle in February

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--> Rate cut cycle to start soon. The benign momentum of December CPI inflation
reinforces that the disinflationary impulse has continued beyond the transient baseeffects
and appears more fundamental in nature. Meanwhile, the still sluggish demand
side of the economy has kept core inflation subdued. We believe the RBI will be able to
start the rate cut cycle by February; with room for 100 bps of rate cuts by end-CY2015.

Another good month for CPI inflation

Even as headline CPI inflation rose to 5.0% in December (as the base effect dissipates), the rise

was more muted than expected. Encouragingly, the sequential quarterly momentum has also

been easing since middle of CY2014 and is currently tracking ~3.1% (3M/3M SAAR), picking

up marginally from November. The downward surprise in December was due to a sharp

sequential contraction in vegetable prices ((-)7.9% mom); much higher than suggested by

higher frequency vegetable prices data available from government agencies. Food inflation was

4.8% in December, higher than 3.1% in November as the base effect wore off.

Core inflation drops

CPI (ex food and fuel) inflation fell to 5.2% from 5.5% in November. In CY2014, core CPI

softened by 2.9%. The sequential momentum in core inflation continues to fall hinting at (1)

muted demand-side pressure (on account of a tight monetary policy) and low pricing power of

producers and (2) reduction in producers’ input prices owing to global disinflationary trends.

The miscellaneous items inflation (comprising education, medical care and household requisites)

printed 4.0% (down from 4.2%), while housing inflation was a tad lower at 7.8% (7.9% last

month). Core inflation is likely to ease further in coming months, averaging ~6.2% in FY2015

(compared to 8.1% in FY2014) and likely reducing further to an average of 5.5% in FY2016.

November IIP shows signs of a pick-up

IIP growth picked up in November to 3.8% yoy from a sharp contraction of 4.2% in October.

We had highlighted that we expected IIP growth in November to pick up partly due to pick-up

in production and also due to base effects. The core sector growth, auto sector production as

also export growth in the month had hinted at this rebound. Capital goods production

rebounded sharply to 6.5% from (-)3.2% in October. Consumer durables production

contracted 14.5% ((-)35.2% last month) and non-durables production grew 6.0% ((-)3.3% in

October).

RBI likely to start the rate cut cycle in February

The December CPI inflation print was crucial as it was the first print sans the base effect which

had been helping the inflation prints over last few months. The favorable inflation print has

hinted at a sustained disinflationary impulse that is likely to continue over the next few months

given the general global disinflationary trends. We now estimate the January-March 2015

inflation to average ~5.7%—lower than the latest published fan chart of the RBI. Thus, there

now appears a bigger probability for monetary accommodation to start as early as the February

policy meeting. Of late, with the UST 10-year yield moving to a sub-2% zone, fears about the

currency side due to an eventual interest rate rise in the US appears to be lower. Even as the

global risk perspectives remain dynamic, the current conditions may provide an outer limit of

cumulative 100 bps reduction in the repo rate (we had earlier factored in 50-75 bps cut).

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily13012015ba.pdf