Or result in significant savings for the retail consumer
Though everyone is aware of this, we will look at the backdrop differently. We will look at three key events panning out before the rate cuts. If you look at some indications that the RBI gave in its policy statements, you will realise that the central bank needs to see the trajectory of interest rates after the base effects have worn off.
We have seen the CPI (Consumer Price Index) decline on a very positive base effect from 2013. Now, the RBI will go through the December-January inflation data before the budget. And after the budget in February, we will be entering a period where the Federal Open Market Committee, which looks after the US’s open money market operations, is expected to give some indication on the June rate hike. There is a feeling in the international markets that the Fed wants to go for a rate hike for the first time since 2006. When all these things are available to the RBI, it will be in a position to take a judicious decision on rate cuts. It is unlikely that it will follow one variable just because the CPI is coming down.
The RBI is looking at inflation, fiscal consolidation and the risk to the financial market because of the Fed’s rate action. If the Fed raises rates, there is a chance that foreign capital in the Indian markets will follow the high interest rates in the US. This will also put the rupee under pressure.
Having said that, we believe that the first rate cut will take place before March 2015, but only if the following scenario doesn’t turn into a big impediment. The markets did not anticipate the sell-off in the emerging markets. Today, the rupee is at around 62 against the dollar. But the rupee depreciation story is not India-specific. Russia had a big currency crisis and hiked rates from 10 to 17 percent. All emerging markets have seen their currencies depreciate.
Today, if you look at where the 10-year bond is trading, it is not only discounting one rate cut but the possibility of a second one. This, from a markets perspective, is aggressive positioning.
The yields for the 10-year bond were at 8.61 percent in January 2014. But it fell to 8.22 percent by end-December as oil prices started to crack. It went down further at the start of 2015 to 7.8 percent despite the policy rate staying at 8 percent. This shows the markets were building in rate cut expectations in the long-term yields.
(This story appears in the 06 February, 2015 issue of Forbes India. To visit our Archives, click here.)