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India’s central bank expected to lay groundwork for rate cuts

New governor likely to initially shift policy stance to neutral in Modi's favor

MUMBAI — India’s Monetary Policy Committee will meet under new Reserve Bank Governor Shaktikanta Das for the first time on Thursday, amid expectations that the status quo on key interest rates will be maintained as the populist budget revealed last week by the administration of Prime Minister Narendra Modi could stoke inflation.

The outcome of the three-day meeting that began on Feb. 5 is being closely watched by investors, market participants and economists alike as to whether the bank’s committee will hold steady or choose to cut rates despite inflation upsides expected from the interim budget proposals. Das, considered to be closely aligned with the government, was appointed to the RBI’s top post just a day after predecessor Urjit Patel’s unceremonious exit in December.

Experts believe the fact that the government missed its fiscal deficit target for the financial year ending March and set a higher target for the next financial year at 3.4%, from 3.3%, will persuade the central bank committee to keep a cautious stance on inflation, even though it reached an 18-month low of 2.19% in December. The government’s borrowing forecast for the coming year has increased to 7.1 trillion rupees ($99 billion).

“The budget does marginally alter our macro view, as it adds upside risk to both growth and inflation,” Nomura said in a note. “We view the budget as slightly expansionary; it will boost consumption, but likely at the cost of crowding out private investments.”

“We expect the RBI to flag the budget as an upside risk to inflation,” Nomura added. “The expansionary fiscal impulse, at the margin, negates the need for the RBI to consider monetary easing. At its Feb. 7 policy meeting, we expect the MPC to vote 5-1 to keep the repo rate unchanged”.

However, Nomura also added that the committee might change its stance to ‘neutral’ from ‘calibrated tightening’, reflecting balanced growth and inflation risks. Gross domestic product growth is predicted at 7.2% this year.

In its monetary policy review in December, the committee decided to hold the policy repo rate at 6.5% and voted 5-1 to maintain the “calibrated tightening” stance, citing an “increase in inflation in items excluding food and fuel.”

Former governor Patel, had however, hinted that the committee could loosen rates soon if inflation risks subside.

According to Capital Economics, which also expects rates to be held, Das is likely to use the meeting to lay the groundwork for policy loosening over the coming months, meaning the official policy stance will change and the hawkish rhetoric of his predecessor will be dialed back in the policy statement.

“Given his close connections to the government, our initial judgement was that Mr Das would be more amenable than his predecessor to the government’s wishes to keep policy loose,” Capital Economics said in a note on Jan. 30.

“The limited evidence so far suggests that this will be the case,” the note said. “For example, Mr Das wasted little time in easing lending restrictions that had been imposed on some of the worst-performing local banks. This was a move that the government had been calling for since the start of 2018, only to be met with resistance by Dr Patel.”

On Jan. 31, the Reserve Bank allowed three public sector banks to exit its prompt corrective action framework. These banks — Bank of India, Bank of Maharashtra and Oriental Bank of Commerce — were part of a group of 11 lenders that were put under the framework in 2017 and 2018 and had become a point of contention between former governor Patel and the government.

In December, the government added 410 billion rupees to its program for capital injections into state-owned banks struggling with bad loans.

The RBI governor is also expected to make announcements regarding banking reforms and increasing liquidity in the shadow banking sector, which is facing a potential crisis due to fraud allegations that surfaced at housing finance company DHFL last week.

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