RBI could cut policy rates even if Fed decides to hike, says report

The Reserve Bank of India could cut policy rates by 75-100 basis points starting early 2015 even if the US Fed hikes rates next year, says a Bank of America Merrill-Lynch report.

According to the global financial services major, the monetary policies of the developed market and emerging markets, especially India, has turned “asynchronous” in recent years.

“We believe that the RBI can continue to cut policy rates by 75-100 bps in 2015 from January to revive growth even if the Fed tapers off,” BofA-ML said in a research report.

The global brokerage firm believes that there are three main reasons why the RBI is likely to go for a rate cut even if the Fed hikes rates next year.

Firstly, the rate differential between India and US are already very high and secondly forex reserves are key to INR stability. Thirdly, a tightening by the Fed is exported to cool “imported” inflation by stabilising commodity prices.

The rate differential between US and India, that stands at 800 basis points, is far higher than the average 460 basis points since January 2003.

Moreover, assuming normal rains, stable oil prices and a stable INR, the country’s CPI inflation is expected to come off to 6 per cent levels by January 2016 in line with the RBI’s targets.

Soon after taking the reins of the RBI in September last year, RBI Governor Raghuram Rajan surprised the industry by hiking the short-term policy rate by 0.25 per cent to keep inflation under check. The repo rate or the short-term lending rate was increased to 7.5 per cent from 7.25 per cent.

Subsequently, RBI raised the repo rate by another 0.5 per cent to keep inflation under check. However, it has kept interest rates unchanged since April this year.

In the recent monetary policy review, RBI kept the policy rate static at 8 per cent, citing upside risks to inflation in view of an uncertain monsoon and its impact on food production as also volatile international oil prices.

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