RBI to Make 20 Bps Rate Cut This Week In Move That Will Invert GDP Projections, Says Singapore's DBS

Reserve Bank of India.

Reserve Bank of India.

The bank pointed out that 2Q (1QFY20) growth numbers released after the August rate decision, disappointed as the actual outcome undershot official projections by 80 bps.

Singapore: The Reserve Bank of India is likely to cut repo rate this week by half of the 40 bps expected in this quarter, Singapore's DBS Bank said on Tuesday. "Of the 40 bps cut we expect in this quarter, half is likely this week," said DBS, also noting the significant variation in market estimates from 5.15 per cent to 5 per cent.

"This will lead to a downward revision in the central bank's official GDP projections, which pegged full-year growth at 6.9 per cent (vs market at 5.8-6.5 per cent)," said DBS.

The bank pointed out that 2Q (1QFY20) growth numbers released after the August rate decision, disappointed as the actual outcome undershot official projections by 80 bps. The RBI monetary policy committee (MPC) meets this week to decide on rates.

The RBI has front run the regional central banks with a cumulative 110 bps cuts in the repo in 2019, the Singapore bank pointed out in a report How many policy rate cuts are left? A favourable inflation profile and weakness in growth indicators necessitated an accommodative policy stance. With the policy rate now at the lowest since 2010, questions are arising on how low it can go?

Inflation has stayed below target, with a sharp cut in corporate tax rates while positive for growth, has increased fiscal slippage risks at the margin. "This cut, in our view, will reflect the RBI's decision to take the middle path be growth-oriented with an accommodative stance, but also reserve some firepower as fiscal purse strings are being loosened concurrently, said the bank.

A dovish bias will also help undo the rise in bond yields witnessed post-tax cuts, particularly in the short end of the curve. We expect a similar-sized cut in December taking the repo rate to 5% by end-2019. A decision by the MPC to, instead, frontload the cumulative 40bps cut this week will not surprise either, it added.

DBS said its choice of real interest rate quantum points to a terminal policy rate of 4.7%, which leaves room for a 30bps cut in 2020. It expects sub-4% inflation. Low growth over the next four quarters starting 4Q19, "we assume inflation below target at 3.8 per cent and growth at 6 per cent".

Factoring in these and DBS' choice of real interest rate quantum, points to a terminal policy rate of 4.4%, which leaves room for a 60bps further easing in 2020, the bank believes. In recent weeks, the government has warmed up to fiscal stimulus, with an eye on spurring investments and industrial growth, noted the bank.

"If this persists and the stimulus steers clear of directly boosting consumption, we expect the RBI to cut rates, albeit, gradually. "A clear shift towards consumption stimulus, however, might put the RBI on the defensive. By most measures (except the bearish assumption), beyond December 2019, we are about 2-3 rate cuts from reaching the terminal policy level, said DBS.

For the markets, steepening bias for the INR sovereign bond curve will continue. The short-end of the curve is held down by rate cut expectations, but longer-end faces bouts of fiscal-related concerns.

Short-term wariness was allayed after the 2HFY20 borrowing plan was maintained with a gross issuance of INR2.7trn i.e. 38 per cent of the full-year target. The nitty-gritties involve auctions to be spread over 17 weeks and will conclude by late-January, instead of running until early-March as in the past.

It said 60% of the issuance will be in the 5Y to 14Y bucket, heavier at the higher end of the duration. Less than 5Y at 7 per cent of total. An unchanged borrowing schedule provides temporary relief to the markets.

Monthly fiscal math will be watched for direct and indirect tax revenue trends which will become clearer in 4Q19 and dictate the need for a wider fiscal deficit. Apart from tax revenues, the math might require renewed push towards disinvestment, other support (dividend payout, subsidy rollovers etc) and expenditure curtailment. Prima facie, we see risks of a miss to the FY20 fiscal deficit target to 3.5-3.6 per cent of GDP vs budgeted 3.3 per cent," cautioned DBS.

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