Research House Says One More RBI Rate Cut Possible in December

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The Reserve Bank of India still has room to cut rates again this year even as it maintains its neutral policy stance and expects inflation to rise from an all-time low, according to Bank of America Merrill Lynch.

The big macro theme of poor growth and low inflation currently playing out is unlikely to end anytime soon,” said Indranil Sengupta, economist at BofAML, in a conversation with BloombergQuint.

We expect the RBI MPC to cut rates by a final 25 basis points on 6 December

Indranil Sengupta, Economist-India, Bank of America Merrill Lynch 

The research house had forecast Wednesday's 25 basis point rate cut at the beginning of the year and stuck to it despite a change in the central bank’s stance from accommodative to neutral. “We thought this is when the RBI will get clarity on rains, therefore if they were normal, it would help them to cut rates,” Sen Gupta said.

He expects inflation to rise to 4.5 percent as the base effects start reversing. “Given that growth will remain weak, there is sufficient room to cut [rates] once more,” he said, adding that higher inflation will not be a concern as long as it remains below RBI’s inflation target.

“Structurally, I am looking at much lower overall rates but timing is going to be difficult,” said Jayesh Mehta, country treasurer at Bank of America.

But is lower headline inflation the new normal?

When you’re in a world where growth is weak, it is fairly logical to expect that inflation should be low

Indranil Sengupta, Economist-India, Bank of America Merrill Lynch 

Bank of America Merrill Lynch expects the central bank to hit a “long pause” after another rate cut of 25 basis points, it said in a report after the policy review.

‘Constrained Loan Growth Keeping Rates High’

The RBI signalled it will continue to drain surplus liquidity from the banking system, which surged after demonetisation, using a variety of liquidity management tools.

The large part of liquidity is in the money markets, Sengupta said. The overall liquidity, that is the money supply coming in is running at 6-7 percent, keeping the loan growth constrained at 5-6 percent, he added.

"That is keeping interest rates high", he added.

Sengupta was of the view that the RBI will have to inject liquidity at some stage in the future to boost credit growth. "Clearly, if loan growth is constrained you're not going to see a recovery", he said.

If the liabilities of the banking sytem are capped, then the assets cannot grow beyond a point. At some stage, you have to have more liquidity which will pull down lending rates and you will see loan growth

Indranil Sengupta, Economist-India, Bank of America Merrill Lynch 

The research house expects banks to cut lending rates by around 25 basis points in response to RBI's rate revision. Lower lending rates will push up credit offtake to 15 percent, from the current 6 percent, BofAML said in its report.

Read more on RBI’s monetary policy on BloombergQuint.

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