Policy Rates Hit Neutral, No Cuts Seen Till 2017: Nomura

Mumbai: With the second surprise of a 25 basis points repo rate cut by the Reserve Bank of India on March 4, the policy rates have reached neutral and the average policy rate over the next three years should be around 7.4 per cent, says a report.

"Based on our inflation and growth forecasts, and the RBI's inflation targets, we estimate that the average policy rate over the next three years should be around 7.4 per cent as the policy rates have reached neutral," Japanese brokerage Nomura said in a note.

It can be noted that RBI Governor Raghuram Rajan took the markets and analysts by surprise within two months by reducing the short term lending rates by 25 bps to 7.5 per cent on March 4 after a similar inter-meeting cut on January 15.

Mr Rajan cited lower inflation, credible and high quality fiscal consolidation, and exchange rate appreciation as the key reasons for the policy action.

He also said two factors justified the inter-meeting action - weak growth and the global trend towards easing; and the need to offer guidance on how it will implement the new flexible inflation targeting mandate.

The economists, however, said they see "a risk of another 25 bps cut this year", but have maintained its baseline view of no further cuts.

"In our view, with growth shifting higher, the government already focused on reviving growth by kick-starting public investment in infrastructure, inflation is likely to stabilise at 5-5.5 per cent and external risk factors growing, the case for incremental monetary policy easing no longer exists, if the RBI is serious about 4 per cent inflation," its economists said.

They said interest rates have reached around neutral levels and expect policy rates to remain unchanged at 7.5 per cent until 2017 and that if the RBI cuts more, there will be rate hikes in FY17 to push inflation down to 4 per cent by March 2018.

Terming the rationale laid out by Mr Rajan for this inter-meeting cut as "very weak", they said the real reason for the cut may lie outside the economic domain and could be a quid pro quo for the monetary policy framework, where the government has largely accepted the Urjit Patel committee recommendations.

On inflation, the report said it expects inflation to undershoot the RBI's targets until January 2016, remain largely around the targets in FY17 and overshoot in FY18.

"This is because the complete pass-through of lower oil prices is yet to materialise, which may result in some undershooting of CPI in H1 of 2015."

"However, with oil prices now inching higher, growth recovering and both fiscal and monetary policy turning less restrictive, we expect CPI to stabilise in a range of 5- 5.5 per cent," they said.

The brokerage is bullish on the rupee as it expects the latest rate cut to raise growth expectations, help attract further foreign inflows into the local asset markets.