Late last month, we asked how long it would be before the RBI hit back in the wake of China’s yuan deval.
The Indian government’s chief economic advisor Arvind Subramanian had just told ET Now television that India may need to "respond" to China’s monetary policy stance, and also hinted at further export weakness. It wasn’t hard to read between the lines: more shots were about to the be fired in the ongoing global currency wars.
Reinforcing that contention was the following from Deutsche Bank:
India’s export sector continues to be under pressure, with merchandise exports contracting yet again in July by 10.3%yoy. The weakness in India’s exports is striking (this is the eighth consecutive month of decline), not only in terms of past trend, but also from a cross country perspective. Indeed, India’s exports performance has been the weakest in the region thus far in 2015. In the first quarter of the current fiscal year (April-June’15), Indian exports have contracted by 17%yoy, one of the sharpest declines on record. The main reason for such a weak Indian export performance can be attributed to the sharp decline in oil exports (down 51%yoy between April-June’15), which constitute 18% of total exports.
Another factor that could likely explain the weak performance of exports is the probable overvaluation of the rupee. As per RBI’s 36-country trade based real effective exchange rate, rupee remains overvalued at this juncture and this could be impacting exports to some extent, in our view.
Currency competitiveness is an important factor in influencing exports performance, but global demand is even more important, in our view, to support exports momentum. As can be seen from the chart [below], global demand remains soft at this stage which continues to be a key hurdle for exports momentum to gain traction.
And here's what Citi had to offer:
The likelihood of a rate cut at the RBI policy review on September 29 has risen given the downside surprise from July CPI inflation and the disinflationary impulse from the continued slide in commodity prices. But market pricing does not seem too far from that outcome. 1y ND-OIS is pricing in about 80% probability of a 25bp rate cut in September (and unchanged rates thereafter).
So while the writing was on the wall for a rate cut, the degree to which the RBI is concerned was apparently lost on most economists and while RBI Governor Raghuram Rajan has a reputation for keeping forecasters guessing, it's nevertheless notable that only 1 out of 52 had predicted the 50bps cut that came on Tuesday. As noted earlier this morning, here's what happened after the announcement:
The announcement catalyzed a dramatic move in the all important USDJPY, which after sliding to a low of 119.250 overnight just after the RBI surprise announcement, started its usual dramatic levitation to the 120 "tractor" point, and around 5am Eastern, the latest central bank intervention to stabilize the market selloff succeeded, with the key carry pair trading within a fraction of the magical support level that is so instrumental to keep stocks bid.
Apparently, the global rout in commodity prices has given Rajan more room to ease via imported deflation. Here's Goldman's summary:
The Reserve Bank of India (RBI) cut the policy repo rate by 50bps to 6.75%. This was ahead of market expectations of a 25bps cut, and our expectation of a hold. The Cash Reserve Ratio (CRR) remains at 4.00%.
The RBI reduced its GDP growth target to 7.4% from 7.6% for FY16. It mentioned that underlying activity remains weak on account of a sustained decline in exports, rainfall deficiency, and weaker than expected momentum in industrial production and investment activity.
The RBI released its CPI forecasts for FY17, and suggests a declining path for inflation. While the CPI forecast for January, 2016 is at 5.8%, only a shade lower than its August projection of 6%, the CPI forecast for early 2017 has been given as 4.8%. This suggests that the RBI expects inflationary pressures to continue to come off over the next 18 months, despite GDP growth accelerating from 7.4% in FY16 to 8% by Q4, FY17. The basis for the larger-than-expected rate cut seems to be this decline in the new CPI forecast for FY17.
In justifying its aggressive rate cut, the RBI mentioned a number of reasons. According to the RBI, despite the monsoon deficiency, food inflation pressures have been contained due to resolute actions by the government to manage supply. The RBI think that, looking forward, subdued international food price inflation should continue to put downward pressure on domestic food prices. Finally, given weakness in global activity, and still-low industrial capacity utilization, ‘more domestic demand is needed to substitute for weakening global demand’. The RBI has reduced its assumption for oil prices to US$50 a barrel instead of US$ 60-63 in its April projections.
The aggressive rate cut by the RBI has come as a big surprise to us. We think that there was a clear change in the RBI’s stance, from the hitherto hawkish tone on inflation. While meeting the January, 2016 inflation target of 6% was not in doubt, we think that the RBI’s inflation projections for FY17 are optimistic, given risks to food prices, an impending civil service wage hike, high inflation expectations, and a narrowing output gap. The language was also markedly different from the August policy statement, where the RBI was awaiting greater transmission of its front-loaded past actions. Despite no further transmission having occurred, the RBI has ‘front-loaded’ policy action by reducing the policy rate by a further 50bps. Since the market was pricing in 25bps of rate cuts, we think the RBI’s action is essentially to get ahead of market expectations, and use the window available before the Fed starts hiking rates. While the language is dovish, given the aggressive front-loading, and the optimistic inflation projections, there would need to be very significant downside surprises on headline inflation from its projections for the RBI to cut rates again, in our view.
In other words, Goldman seems to think that the RBI may now be out of ammunition unless inflation surprises markedly to the downside. As Bloomberg notes, we'll now see whether the central bank can succeed in fixing a transmission mechanims that seems to be impaired by banks' concerns over souring loans. Of course the other thing to note here is that India is a major emerging economy and Rajan's move to lean dovish means that if the FOMC does hike, the policy divergence between the Fed and the RBI will be that much greater, which could accelerate capital outflows.
In any event, another day, another rate cut as the global currency wars continue unabated. We'll close with something Rajan said last month as it seems particularly amusing in light of today's move:
"Rate cuts should not be seen as goodies that the RBI gives out stingily after much public pleading."