Indian Rate Cut: Beginning Of An Upbeat Story

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Includes: EPI, INDA, INDL, INDY, INP, INXX, PIN
by: Invesco US

Summary

The central bank’s rate cutting well ahead of market expectations clearly indicates that the RBI is comfortable with India’s current level of inflation.

The government’s commitment to fiscal policy suggests that this is just the beginning of a monetary easing cycle.

The possibility of additional monetary easing removes uncertainties, boosts business confidence, and helps kick-start capex in the short term.

By Shekhar Sambhshivan

The Reserve Bank of India (RBI) surprised markets on Jan. 15 by cutting its bank lending rate by 25 basis points (BPS) to 7.75%,1 ahead of its scheduled policy meeting on Feb. 3. The RBI kept its cash reserve ratio- the percentage of deposits the bank is required to have on hand as cash - unchanged at 4%,1 while the marginal standing facility rate - which allows banks to borrow more money than is available through repurchase (REPO) agreements -moved down to 8.75%.1

Inflation under control

Despite signaling earlier that a rate cut was imminent, the central bank's action occurred well ahead of market expectations and, in my view, is a clear indication that the RBI is comfortable with India's current level of inflation. The RBI's target is 6%,1 and current consumer price index stands at 5%.2 Meanwhile, India's producer price index is currently 0.11%,2 compared with more than over 5% up to July 2014.3

Beginning of monetary easing cycle?

In addition to limited inflation risk, I believe a motive for the RBI's early interest rate cut is the government's assurance about its commitment to fiscal policy plans. India's annual budget will be unveiled in late February, and the RBI has said the government should undertake fiscal consolidation if interest rates are to be lowered. The government's intention is to achieve its fiscal deficit target of 4.1%,4 which helped open the door for the RBI to ease policy, in our view.

It appears likely that the RBI won't flip-flop with policy, suggesting that this is just the beginning of a monetary easing cycle. How many rate cuts should we expect? Some observers speculate that the total could be 100 to 150 bps and even suggest that another rate cut could be announced at the RBI's February meeting.

Support for business growth dynamics

In my view, India is in the early stage of a business cycle recovery. Currently, impaired balance sheets of certain corporations and the banking sector, along with low capacity utilization, impede a revival in the capital expenditure (CAPEX) cycle.

We believe a lower interest rate will help support corporate growth dynamics by spurring investment.

The prospect of additional monetary easing could help remove uncertainties, boost business confidence, and most importantly, it could kick-start capex in the short term. Longer-term growth dynamics will require a continuation of the government's efforts to revive the investment cycle. The business recovery will also depend on whether the government is able to:

  • Address various structural issues weighing on the economy, including labor laws and land acquisition issues.
  • Restart stalled projects directed toward improving economic productivity.

Upbeat story in India for 2015

We think the RBI's accommodative policy move is definitely positive for equity markets in the region and clearly boosts investor sentiment and confidence. While it's very early in 2015, India's lower inflation and improving business growth dynamics set the stage for a promising story to unfold in the region, in our view.

Sources

  1. Reserve Bank of India, Jan 15, 2015
  2. trading economics.com, Jan. 15, 2015
  3. Bloomberg L.P., as of Dec. 31, 2014
  4. Business World, as of Dec. 19, 2014

Important information

A basis point equals to 1/100th of 1%. The consumer price index measures changes in the price level of a market basket of consumer goods and services purchased by households. The producer price index measures the average changes in prices domestic producers receive for their output.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The performance of an investment concentrated in issuers of India is expected to be closely tied to conditions within India and to be more volatile than more geographically diversified investments.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

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