RBI seen cutting rates to over 6-1/2 year low, faces pressure to do more

Mumbai: The Reserve Bank of India will likely cut its main policy rate on Wednesday by a quarter percentage point to a more than 6-1/2 year low after inflation slumped. The question is whether the cautious central bank will signal readiness to ease more.

Forty of 56 economists polled by Reuters predicted the RBI will cut its repo rate by 25 basis points to 6.00 percent - the lowest since November 2010 - as a slump in food prices sent June consumer inflation to a more than five-year low of 1.54 percent.

That`s well below the RBI`s 4 percent target and its projection of 2.0-3.5 per cent in April-September, sparking pressure from the government and others to cut rates by 50 bps on Wednesday or signal another 25 bps easing later this year.

The central bank has previously warned that inflation could accelerate due to a seasonal rebound in food prices and factors such as planned pay hikes for government employees.

Retaining a cautious stance could cause tension with a government keen to lift the economic growth from January-March`s 6.1 percent - fast by global standards but the lowest in over two years.

Proponents of more rate cuts argue these would make loans cheaper and help companies refinance their debt, while potentially helping reduce some of the $30.3 billion in capital inflows into stocks and debt markets lifting the rupee by 5.6 percent against the dollar this year.

These arguments were seemingly given a boost after a private survey on Tuesday showed Indian factory activity suffered its deepest contraction in more than nine years after confusion about the new goods and services tax battered output and demand.

`BENIGN` TRAJECTORY

Shubhada Rao, YES Bank chief economist, said a 50 bps rate cut "will be more effective" and that inflation is on a "benign" trajectory though she added that the RBI may adopt a measured approach. YES Bank has cut its 2017/18 average inflation projection to 3.5 percent from 4 percent.

Yet markets are unwilling to wager strongly on more aggressive rate cuts, with most analysts polled by Reuters expecting the repo to stay at 6.00 percent for a long time after Wednesday.

Doubts about the RBI`s policy path reflect its longstanding caution on inflation.

After a 25 bp cut in October, the RBI has kept rates at 6.25 percent and shocked markets by changing its stance to "neutral" from "accommodative" in February.

The RBI sharply cut its inflation forecasts at its last meeting, in June, but it still believes consumer prices in October-March will rise 3.5-4.5 percent from a year earlier.

The government`s chief economic adviser, Arvind Subramanian, and others call the projections too high, as efforts to curb food prices and low energy prices will keep inflation low for some time to come.

The RBI`s stance has its defenders, including IDFC Bank chief economist Indranil Pan who, like the central bank, believes inflation will accelerate in two months. He said it should not cut rates on Wednesday.

"Given that the central bank is under a inflation targeting regime, it doesn`t make sense to cut rates when you know that inflation will rise going ahead," Pan said.