The Reserve Bank of India (RBI) is expected to keep key policy rates and reserve ratios unchanged on Tuesday at its sixth bi-monthly monetary policy review for 2015-16 as retail inflation is close to the bank's January 2016 target of about 6 per cent.
"We expect the Reserve Bank of India to keep rates on hold on 2 February. After 125bps worth rate cuts in 2015, the benchmark Repo rate is likely to be held at 6.75% and reverse repo at 5.75%. Reserve ratios will be left unchanged, we reckon," said Radhika Rao, economist, group research, DBS Bank, in her note on Monday.
"From a low of 3.9% YoY in the September quarter, inflation rose to more than a year's high at 5.6% YoY by December," she said in support of her argument.
Another influencing factor is the government's commitment to the fiscal consolidation roadmap, which necessitates the government to contain the fiscal deficit at 3.9% of the GDP in FY2016 and bring it down to 3.5% next financial year, which would be tough to achieve given the proposals of the 7th Central Pay Commission.
"The key risk is the implementation of the pay commission's proposals. If the panel's recommendations are adopted at the FY16/17 Budget next month, there will be a temporary spike in prices when the increment kicks-in this year," she said.
Stock market movements in January would also weigh on the RBI's stance, she said. "Tuesday's policy guidance by the RBI is likely to signal caution on last month's volatility."
Indrani Pan, chief economist at non-banking finance company IDFC, also said that a status quo is the most likely outcome, reported moneycontrol.com.
"We are not expecting the Reserve Bank of India (RBI) to cut rates nor actually do anything much in terms of the liquidity, he said, adding, "We do expect the RBI to actually sort of move by around a minimum of 25 and a max to max a 50 basis points in the next financial year and that is more specifically post to the Union Budget."
In favour of a rate cut
In sharp contrast to the above view, Bank of America-Merrill Lynch (BoA-ML) said that there is a strong case for the RBI to reduce the policy rate by 25 bps.
"Our economists are expecting the RBI to ease policy rate by 25bp in the upcoming meeting on 2nd Feb. This is somewhat justified given that oil prices have fallen considerably since the last RBI meeting and the recent dovish rhetoric from the RBI governor Raghuram Rajan," BoA-ML said in a note on Monday.
At the same time, it is said that the rise in inflation and likely widening of the fiscal deficit in the next fiscal leave little elbow room for the RBI.
"The RBI is now targeting 5% inflation for next year. The recent pick-up in inflation and possible widening of fiscal deficit in FY2016-17 does not likely leave much room for the RBI to sound extremely dovish, at least in the short term."
Poor rate cut transmission
The apex bank would also be sceptical of a rate cut given that earlier rate cuts were not transmitted by lenders. "...since the rate reduction cycle that commenced in January, less than half of the cumulative policy repo rate reduction of 125 bps has been transmitted by banks. The median base lending rate has declined only by 60 bps," the RBI had said in its statement issued after its fifth bi-monthly monetary policy review on 2 December, 2015.
Indian stock markets ended on a subdued note ahead of the 2 February policy meet, with the Sensex ending the day at 24,824, down 45 points, or 0.18 per cent, while the NSE Nifty settled at 7,555, down 0.10 per cent. The NSE Bank Nifty was down 207.95 points, or 1.34 per cent, to close at 15,314.45.