E
CO
S
COPE
RBI cuts policy interest rate, but maintains neutral stance
Favorable data to lead to another rate cut in October
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2 August 2017
The Economy Observer
In line with market expectations, the Monetary Policy Committee (MPC)
decided to cut the repo rate by 25bp to 6%, but maintained its ‘neutral’ policy
stance adopted in February 2017. The decision was taken with a majority of 4-
2 votes. The move was in contrast to our fear that the central bank would
maintain status quo due to the MPC’s bias towards not changing rates (for
more details refer to our
monetary policy preview note).
As far as the economic forecasts are concerned, the RBI has maintained its FY18 real GVA growth and inflation forecasts
at 7.3% and ~3.5%, respectively.
Although the RBI sounded extremely cautious, we believe it will remain data-dependent. Over the next two months, we
expect retail inflation to remain below, but close to, 2%. We also expect real GDP to grow ~6.5% in 1QFY18 (refer our
June economic activity report).
Accordingly, we believe favorable data will prompt the RBI to cut policy rates again on 4
October 2017.
If the states were to
increase salary &
allowances similar to the
Center in the current
financial year itself, this
could add ~100bp to the
headline inflation number
We believe favorable data
will prompt the RBI to cut
policy rates again on 4
October 2017
RBI cuts policy rates, as expected…:
The RBI cut policy rates by 25bp in its Third
Bi-monthly Monetary Policy Review held today, taking the repo rate to 6%, the
reverse repo rate to 5.75% and the marginal standing facility (MSF) rate to
6.25%
(Exhibit 1).
The cut in rates was in line with market expectations, but in
contrast to our fear that the RBI would maintain status quo on account of the
MPC’s bias towards unchanged rates. The decision to cut rates was taken with a
majority of 4-2 votes. Of the two members not in favor of the decision, Dr
Ravindra Dholakia voted for a cut of 50bp, while Dr Michael Patra voted for
status quo. The MPC continued with its ‘neutral’ policy stance.
…but sounds cautious on inflation:
Even though the MPC maintained its
inflation forecast at ~3.5% for FY18, it remained extremely cautious on the
future inflation trajectory. The MPC highlighted that it was not possible to
determine whether the recent decline in inflation was driven by transitory or
structural factors, and that there were upside risks to inflation emanating from –
(1) the implementation of farm loan waivers and (2) the implementation of
salary & allowances by the States. According to the RBI, if the states were to
increase salary & allowances similar to the Center in the current financial year
itself, this could add ~100bp to the headline inflation number (not factored in its
inflation projections). Moreover, despite the recent low inflation, household
inflation expectations also hardened in the June 2017 Survey.
Expect another rate cut in October policy:
Given that more clarity on the impact
of GST and the implementation of HRA hikes by the Center on inflation is
expected to emerge in the coming months, the RBI’s data-dependent stance is
justified at the current juncture. However, we believe that retail inflation will
undershoot the RBI’s trajectory, remaining below-2% levels over the next two
months. Besides, GDP growth is also likely to remain weak at 6.5% in 1QFY18 –
the second consecutive quarter of sub-7% growth. Hence, we believe favorable
data will prompt the RBI to cut policy rates again on 4 October 2017.
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.

Exhibit 1: RBI cuts policy rates
9
8
7
6
5
4
(%)
Oct-15
Mar-16
Jul-16
Nov-16
Mar-17
Aug-17
Exhibit 2: Liquidity remains extremely comfortable
MSF
4
2
0
(2)
(4)
(6)
(8)
Aug-15
Dec-15
Apr-16
Aug-16
Dec-16
Apr-17
Jul-17
(% of NDTL)
Liquidity deficit
Repo
Reverse repo
Jun-15
Source: RBI
Source: RBI
Exhibit 3: RBI sees upward trajectory in inflation in FY18…
Exhibit 4: …and expects GVA growth to pick up from 6.9% in
FY17 to 7.3% next year
Source: RBI
Source: RBI
2 August 2017
2

NOTES
2 August 2017
3

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2 August 2017
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