Inflation cools while industry sputters – How, why and when will RBI respond?

High inflation has severely undermined India’s economic growth since 2012, prompting RBI to unveil a series of aggressive interest rate hikes and adopt inflation targeting as its monetary policy regime. Reassuringly, the past six months have seen inflation pressures dissipate beyond RBI’s expectations, raising the clamor for the RBI to cut policy rates to aid the weakening industrial activity. Although still wary of premature policy easing, last policy meeting saw RBI signal likely rate cuts early 2015 if current inflation momentum continues. While we expect RBI to ease policy rates by 25 bps at its next meeting on February 3rd 2015, a surprise pre-policy cut cannot be discounted. In this context, the December inflation out-turn, which releases mid-January 2015, will be a key input for RBI in timing its next policy move. For the full year 2015, we expect RBI to cut policy rates by a cumulative 50-75 bps. However, given a weak monetary policy transmission, we maintain that an interest rate cut at this juncture would serve largely as a signal rather than a precondition to revive India’s sluggish growth.

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