Markets are primed for the RBI monetary policy committee (MPC) rate decision on Feb 7. We expect the MPC to vote for a 25bp rate cut in the repo rate to 6.25% after an extended pause since February 2023. Our expectation for a cut is based on three factors. Jan inflation is likely to ease to 4.5% yoy vs Dec’s 5.2%, on broad-based deceleration in food, winter disinflation in staples as well as perishables, strong production in the kharif crop and on-track rabi sowing activity. Into FY26, we expect the headline to slow towards 4%, barring unexpected supply shocks. Secondly, with the fiscal policy assuming a contractionary impulse on the back of a narrower deficit target for FY26 (Budget note), the monetary policy is likely to assume a growth supportive stance. Lastly, high frequency indicators point to a slowdown in the growth momentum. The statistics agency projected first advance real growth estimate for FY25 at 6.4% yoy, aligning with the slowdown signaled by the revised RBI’s projection at 6.6% (from 7%+ earlier) and our forecast at 6.3% (2025 outlook).
Could recent weakness in the currency pose a hurdle to rate easing plans? Recent rupee depreciation has raised concerns over pass through to price pressures. A 5% deprecation in the currency adds 0.35pp to headline inflation according to the central bank, although manufacturers are unlikely to immediately and fully pass on costs amidst the ongoing cyclical slowdown. An escalation in US-China trade skirmish will also impart a deflationary impulse as China will seek to channel more exports into this region. Risk of transmission from higher oil onto local fuel prices is limited as official preference will be to keep domestic petrol and diesel costs unchanged to preserve households’ purchasing power. Rate differentials are less of a hurdle as equity markets had witnessed bulk of the flows in the past two years, whilst the index inclusion tailwind benefited bonds.
On liquidity, the RBI has introduced a host of measures to inject temporary liquidity in recent months (RBI takes action to ease liquidity conditions) boding well for transmission, though more steps will be necessary to narrow the deficit this month and in March. Policy responses are diverging in the region, as central banks weigh domestic priorities vis-à-vis volatility in their currency and bond markets due to global triggers, opting to be opportunistic with their policy response. Repricing of growth and earning expectations alongside a bid dollar drove rupee to a fresh low, with USDINR closing around mid-87 handle testing past our Mar25 target, down 2% YTD and amongst the underperformers in the region. Dovish surprises by either a change in stance or outsized rate cuts are unlikely, in our view.
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