Rajan cuts India rate, says next move hinges on monsoon rain

The move, which takes the rate to the lowest since September 2013, was predicted by 33 of 41 economists in a Bloomberg News survey.

Seven saw no change and one expected a 50 basis-point cut. While “a conservative strategy would be to wait” for more certainty on how monsoon rains will affect inflation, weak investment means “a more appropriate stance is to front-load a rate cut today and then wait for data that clarify uncertainty,” Rajan said.

He also lowered the RBI’s growth forecast and said inflation risks are tilted on the upside. The decision follows China’s cuts and comes just months before an expected increase in US interest rates that risks triggering outflows from emerging markets.

Room to ease policy may reduce if oil prices continue rising and monsoon rains are less than normal. “Today is the last cut before it pauses for some time,” said Suvodeep Rakshit, an economist at Kotak Securities Ltd in Mumbai.

“At least for the next three months I don’t think they are looking at any kind of easing.”

Stocks fall

The benchmark stock index extended losses soon after the decision and was trading 1 percent lower at 12.16pm in Mumbai.

The rupee weakened 0.2 percent to 63.8150 a dollar, the yield on the sovereign bond due 2024 rose to 7.86 percent from 7.82 percent on Monday, and the one-year forward swap rate rose to 7.22 percent from 7.17. Swap traders were betting before the decision that India will cut the key rate to 7 percent by year’s end, the steepest decrease after Turkey among 14 emerging markets tracked by HSBC Holdings Plc. “While the tone is dovish on rate cut, the outlook going forward is hawkish,” Manish Singh, head of investments at Crossbridge Capital LLP, told Bloomberg TV.

“I would expect the market to not take it very kindly.” Consumer prices rose 4.87 percent in April from a year earlier, holding below Rajan’s 6 percent target for an eighth straight month.

While price pressures have so far proved immune to crop damage from unseasonal rains, the weather department predicts monsoon rainfall -- which waters more than half of India’s farmland -- will be below average this year.

‘Goldilocks policy’

“The policy today is neither conservative nor aggressive,” Rajan told reporters after the decision, adding that further moves will depend on data.

“It’s a Goldilocks policy, just right for the existing situation.” Rajan said three risks are clouding the inflation outlook: the possibility of a weak monsoon, rising oil prices and a volatile external environment.

Consumer prices are likely to fall until August and then start rising to about 6 percent by January 2016, higher than projections made in April, Rajan said. “The risks to the central trajectory are tilted to the upside,” he said.

He called for a strong food policy and management to keep inflation contained in the near term, while saying a rate cut will facilitate public investment that eases supply constraints and reduces inflation over the medium term. Since food prices account for almost 50 percent of India’s CPI basket, Rajan has little scope to reduce interest rates if they aren’t contained. He’s also bound by a mandate to lower inflation to around 4 percent in the next few years.

Weak data

It’s crucial for Rajan to gauge the strength of India’s economy. While gross domestic product expanded 7.5 percent in the first three months of the year, gross value added – a component of GDP watched closely by the central bank – gained 6.1 percent versus an estimated 7 percent. Rajan cut the central bank’s projection for GVA growth in the year through March 2016 to 7.6 percent from 7.8 percent earlier.

He also said banks should pass through the sequence of rate cuts into lending rates, and added that a targeted infusion of capital into state-run commercial banks is warranted so that adequate credit flows to productive sectors.

The latest government data show exports dropped for a fifth straight month, factory output slowed to a five-month low and bad loans at banks are estimated to rise to the highest since 2001.

Domestic vehicle sales rose 1.9 percent in April compared with a 7 percent increase a year earlier. “It’s important that there is not such a ready, crystal clear guidance from here on,” Shubhada Rao, an economist at Yes Bank Ltd. in Mumbai told Bloomberg TV India.