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Ghosts of previous stance could delay rate cut

However, a 50bp cut, and not a 25bp cut, is looming



27 July 2017

The Economy Observer

In its upcoming monetary policy on August 2, 2017, a majority of the participants

expect RBI to cut policy rates by 25 basis points (bp), bringing repo rate to 6%.

We believe that the RBI must show conviction in the massive disinflation in the

economy and announce a 50bp cut rather than a customary 25bp cut. However,

the fear of “it’s too early to take a U-turn” and the challenge of a simultaneous

change in the mindset of three committee members (out of five) might postpone

the rate cut to October 2017. In any case, we believe a 50bp rate cut is

imminent.

Motilal Oswal values your support in

the Asiamoney Brokers Poll 2017 for

India Research, Sales and Trading

team. We

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As is almost always the

case, there are an equal

number of factors

demanding caution as the

factors supporting

monetary easing

Assigning weights is critical

While one could talk about several factors supporting a rate cut, the arguments to

remain cautious are equally relevant and valid. As is almost always the case, there

are an equal number of factors demanding caution as the factors supporting

monetary easing.

Exhibit 1

below provides a list of factors in support of monetary

easing and against it.

None of the arguments might appear new. The eventual decision would depend on

the weights assigned to these factors. To our mind, the right-hand side – factors

supporting rate cut – is heavier than the left-hand side, making us a proponent of a

sharper-than-consensus rate cut.

Exhibit 1: List of factors in support of and against rate cuts

Factors supporting caution

1.

2.

3.

4.

5.

Deterioration in quality of states’ fiscal

spending: Farm loan waivers at the cost of

capital spending

Too quick to change monetary stance from

neutral to accommodative

Factors supporting rate cuts

Strong disinflation in the domestic economy:

Persistent lower-than-expected inflation

reading

Weak economic activity excluding fiscal

spending

Policy divergence to narrow rate gap: Monetary Global crude oil prices have stabilized at low

tightening by global central banks

levels

Impact of revision in House rent allowance

(HRA) to be effective from July 2017

Uncertainty regarding GST implementation: All

services have become expensive

Global inflation has subsided: Inflation in G20

down from 2.6% in January 2017 to 2.1% in

May

Better-than-expected monsoon: Surplus of

4.6% up to July 26, 2017

Source: MOSL

List is arranged in descending order of the importance of factors

Nikhil Gupta

-

Research analyst

(Nikhil.Gupta@MotilalOswal.com); +91 22 3982 5405

Rahul Agrawal

-

Research analyst

(Rahul.Agrawal@motilaloswal.com); +91 22 3982 5445

Investors are advised to refer through important disclosures made at the last page of the Research Report.

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Let bias not enter into policy decisions

The RBI’s decisions are independent of the market consensus opinions, and rightly

so. Just because the market now expects a 25bp cut, does not mean that the RBI will

oblige. During its last meeting, when the RBI revised its inflation forecasts

dramatically, many participants questioned the credibility of its projections.

However, some (including us) praised the RBI for being brave enough to accept the

disconnect between its projections and the reality, and for revising the former in

line with the latter. We, in the markets, do it most of the time, and RBI is no

different. What, however, surprised us was the absence of any rate cuts along with

such dramatic reductions in inflation forecasts. After all, policy decisions are argued

to be forward-looking, and if inflation projections over the next 10 months are

revised down from ~4.5% to ~3%, it makes a strong case for immediate rate cut.

We believe the fear of “it’s too early to take a U-turn” may have surfaced, which

may have led to a wait-and-watch policy by four out of six committee members. The

RBI, entirely unexpectedly, changed its monetary policy stance from accommodative

to neutral in February 2017. If four months (in June 2017) is too early, six months (in

August 2017) is not far either. This is where we fear that biases might enter.

Sometimes, it becomes very difficult for analysts to take a U-turn in their views, and

the same could be the case with the RBI. While the RBI was bold enough to revise its

inflation forecasts, it now wants to be doubly sure that it doesn’t have to eat its own

words again 6-12 months down the line. A cautious approach from policy makers is

also well appreciated, because the cost of higher inflation is asymmetrically higher

than postponing rate cuts by a few months in Indian economy. However, caution

should not come from biases.

Possible scenarios on August 2, 2017

Given below is the list of possible scenarios that could play out on August 2, 2017.

We believe that the RBI has sufficient room to cut policy rates by 50bp and stick

with its neutral guidance. However, the ghosts of past stance and the challenge of a

simultaneous change in the mindset of three committee members might postpone

the rate cut to October. In any case, a 50bp rate cut is imminent.

Exhibit 2: Possible rate action/guidance/market reaction in August’s monetary policy

meeting

Action

Possibility I

Possibility II

Possibility III

Possibility IV

Possibility V

Cut rates by 25bps

Guidance

Maintain neutral guidance

Hints at further possible rate cuts

Maintain neutral guidance

Cut rates by 50bps

Hints at further possible rate cuts

No rate cuts

Hints at further possible rate cuts

A cautious approach from

policy makers is also well

appreciated, because the

cost of higher inflation is

asymmetrically higher than

postponing rate cuts by a

few months in Indian

economy. However, caution

should not come from

biases.

We believe that the RBI has

sufficient room to cut policy

rates by 50bp and stick with

its neutral guidance.

However, the ghosts of past

stance and the challenge of

a simultaneous change in

the mindset of three

committee members might

postpone the rate cut to

October.

Expected market

reaction

Negative to neutral

Neutral to positive

Positive

Highly positive

Negative to neutral

Source: MOSL

27 July 2017

2

NOTES

27 July 2017

3

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