What to expect from RBI monetary policy review?

RBI retains its priority on long term inflation comfort

There is no cheer from RBI on successive sub 4% CPI print in July-August 2015, when noise for rate cut has turned into scream! Most take comfort from low CAD at 1-2%, steady fiscal deficit at 3.5-4% and relatively strong Rupee against emerging market currencies. The need is also felt to guide GDP growth into higher end of 7-8% through low interest rate regime, if not through surplus system liquidity. It is more critical to avoid growth slippage below 7% when global rating agencies are already delivering downgrade to both developed and EM countries on risks growth pressures. A downgrade for India at this stage will be suicidal.

RBI see relief on CPI, CAD and Rupee as short term development (from external cues) with no major comfort on fiscal deficit against growth pressures. The sense is that the Government has not done enough to remove structural woes on the CAD and CPI and to spur growth through big-bang policy initiatives and huge investments in infrastructure and core sectors. The concerns on the CAD is from export stagnation (and risk of de-growth), sharp rise in gold imports and doubt on long term sustainability of beneficial impact from crash in commodity prices. RBI continues to stay suspect on CPI stability at lower-half of 4-6% tolerance zone into 2016. The concerns are from supply side issues from monsoon impact, unwind of crash in commodity prices and downside risk on the Rupee. RBI also see monetary support to growth can only be steroid type temporary relief, and not permanent cure. While low interest rate policy is not enough to build sustainable momentum in economic capacity expansion, elevated interest rate alone can't guide soft landing of inflation. In this situation, RBI is firm in its balanced approach, and now seen to bat for "silent" savers rather than "vocal" borrowers. It is also clear that RBI is not keen on short-cut "hook or crook" approach for short term relief, and would prefer "wait-and-watch" approach for long term permanent comfort. All combined, it is obvious that RBI does not see merit to deliver rate cut based on the sub 4% CPI print and to stay focused on long term outlook which is at higher end of 5-6%.

Dilemma between rate cut (with extended pause signal) or rate pause (retaining hope for December cut)

It is not pro-market if RBI delivers 25 bps rate cut with 2016 CPI outlook at 5.5-6%. Signals of end of rate cut in India (with September rate cut) against start of rate hike by FED in October - December 2015 is very bearish on both equity and interest rate markets. The trigger of FII exit (against weak equity and long term base in 10Y yield) will push Rupee down. On the other side, RBI rate pause stance till better clarity from base effect (and monsoon) impact on CPI and timing of FED rate hike may turn out to be neutral stance to provide price stability. Given the logical rationale for and against rate cut, it is 50:50 probability on run upto 29th September policy review date.

Jaitley and Rajan seen walking together on monetary policy

It is clear that the Finance Ministry has agreed to disagree with RBI, cutting off the influencing amblical chord. FM is seen to be ok with whatever Rajan does on 29th September. If given such a free hand, Rajan's preference will be to follow Yellen's foot-steps of staying in pause till July-August impact settle down. Most economists are unanimous on CPI shift into 5.5-6.0% in September 2015 to March 2016, which is in alignment with RBI outlook. Then, why demand for rate cut based on the past rather than the future outlook? Government is seen to see merit in this, hence the removal of pressure on RBI to cut rate, and stay content with the 75 bps ease in Q1/2015.

Markets to position for 50:50 bias ahead of 29th September event day

There are 2 options ahead: either 25 bps rate cut with signals of extended pause or rate pause keeping the option open for 25 bps cut in December if September-October CPI print stay at/below 5.5%. The post-event market impact will be the same, hence it is possible that 25 bps rate cut price-in gets unwound on run upto policy. In either case, price volatility is seen to be restricted - Nifty at 7500-8100, Bank Nifty at 15700-17700, 10Y bond yield at 7.68-7.78% and Rupee at 65-67 awaiting next steps of FED and RBI. On run upto FOMC, global markets unwound rate hike impact - recovery followed by post-event push back. Now on run upto 29th September, India markets will be seen to unwind recent recovery followed by post-event price stability.

Fingers crossed for now; 25 bps rate cut will be a pleasant surprise without positive impact, while rate pause will be unpleasant, but to be taken as bitter-coated sweet pill!

Moses Harding