RBI is likely to deliver 25bps Repo Rate cut on the 2nd of December 2014 policy review.
The last rate action by the RBI was a hike in the Repo Rate from 7.75% to 8% in its 28th January 2014 policy review. At the time of the Repo Rate hike, CPI inflation was at levels of 9.8%, the Fed has started tapering its asset purchase program, which was at USD 85 billion a month and India was heading towards a general election. RBI hiked the rates to temper inflation expectations in the face of a potential volatile economic and political situation in India.
Going into 2nd December 2014 policy review, CPI inflation is at levels of 5.52%, the Fed has stopped its asset purchase program and the country has given a strong political mandate to the Prime Minister Narendra Modi.
RBI Governor Dr. Raghuram Rajan has been steadfast in his campaign against protecting the internal value of the INR. The INR had touched record lows of Rs 68.80 against the USD in August 2013 and is now trading at levels of Rs 62, levels that were seen in January 2014 at the time of rate hike. The INR has withstood a broad USD strength that has taken up the USD index, which tracks a basket of six major currencies against the USD, by over 8%.
The country’s macro is supporting the INR. The government is committing itself to lowering the fiscal deficit to 4.1% of GDP this fiscal from 4.5% of GDP seen last fiscal. Current Account Deficit came in at 1.7% of GDP for the last fiscal and is likely to stay at around 2% of GDP in this fiscal given that trade deficit is negative 1.8% in the April- October 2014 period on a year on year basis. CPI inflation has come off sharply and with global crude oil prices down over 30% this year, key inflation and fiscal deficit drivers are weak. The government has fully passed through petrol and diesel prices to the end user and inflation is no longer suppressed by subsidized fuel though LPG and Kerosene are still subsidized. The government is making efforts to make sure that the subsidy goes to the needy and that would lower the subsidy bill further.
The second quarter fiscal 2014-15 GDP numbers support falling inflation expectations. Industry grew by just 2.2% in the second quarter, down from first quarter levels of 4.2%. Private and Government Final Consumption Expenditure and Gross Fixed Capital Formation have shown declining trends.
The ten year benchmark government bond, the 8.40% 2024 bond saw yields fall 8bps last week to close at 8.09% levels. The market is expecting an outside chance of a rate cut and if expectations are met, the yield on the 8.40% 2024 bond will fall to levels of 7.90%.
The long bond, the new thirty year bond auctioned last week saw the cut off come in at 8.17% levels, which is just 9bps higher than yield on the ten year bond and 2bps higher than the yield on the five year bond. The bullish cut off indicates the expectations of fall in the yield curve by the market.
OIS (Overnight Index Swaps) market saw the curve falling with one year OIS yields falling by 21bps and five year OIS yields falling by 24bps to close at levels of 7.73% and 7.10% respectively. OIS market is factoring in a series of rate cuts starting 2nd December 2014.
System liquidity stayed flat last week. System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in deficit of Rs 689 billion last week from Rs 676 billion seen in the week previous to last. Liquidity conditions are easy structurally and RBI is conducting OMO sale auction for Rs 120 billion on the 1st of December to suck out excess liquidity.