No ties on Dr Rajan

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On 15 January, the Reserve Bank of India (RBI) announced a cut in its key policy rate by 25bp to 7.75%. This is the first rate reduction in almost two years under the governorship of Dr Raguram Rajan. It comes amid signs that India is winning the long battle with inflation thanks in part to falling oil and food prices.

Exhibit 1: Graph showing the Reserve Bank of India’s key lending rate (Repurchase Rate) from 06/2007 – 12/2014. Dr Raguram Rajan announced a cut in the rate from 8% to 7.75% on 15 January.

Rates INDIA

Source: Bloomberg, BNPP IP as of 15/01/15

India benefits from falling oil prices

Dr Raguram Rajan became Governor of the Reserve Bank of India in September 2013. He began his tenure by taking a tough stance on inflation and implemented a series of rate hikes. He set a target of getting the consumer-price inflation (CPI) rate down (from around 10%) to 8% by January 2015 and 6% by January 2016.

India’s inflation rate has since fallen significantly from 11.2% in November 2013 to 5% in December 2014. This is primarily due to lower food price inflation, slowing rural wage growth and the tailwind of lower commodity prices, in particular oil. India imports more than 70% of its oil consumption at a cost equivalent to 5.5% of GDP. It is reckoned that a fall of 10 US dollar in the price of crude oil
reduces CPI inflation by 50bp.

Potential impact of a sustained USD 10/bbl. fall in crude oil prices
on some of India’s key macro-economic variables

 Effect of a decrease of 10 dollar per barrel

There’s more to come, provided disinflation continues

This move marks a clear shift in the RBI’s monetary policy stance. The RBI statement is unambiguous stating that “once the monetary policy stance shifts, subsequent policy actions will be consistent with this stance.”

The shift in the RBI’s policy stance is in our view excellent news for the Indian economy. The economic recovery has taken place under very tight monetary conditions with a key lending rate of 8%. By cutting rates now and holding out the prospect of further rate cuts the RBI provides a much-needed boost to the Indian economy. India’s GDP grew by less than 5% in the year ending in March but has accelerated since and is forecast to grow by 5.5% this year. The start of a cycle of cuts in the RBI’s key lending rate will strengthen expectations of stronger growth this year.

Strong fundamentals support the rupee

India’s macro-economic fundamentals have greatly improved. The current account deficit is now below 2%. The fiscal deficit is expected to come in lower at around 4.1% of GDP and foreign exchange reserves are running at an all time high (above US dollar 300 billion). As a result the Indian rupee has been one of the world’s most stable currencies in 2014. Its depreciated by only 2.18% versus the US dollar and rallied 11.22% versus the euro.

Both the rupee and the Indian stock market responded positively to the news of the rate cut. The rupee strengthened versus the US dollar and the S&P BSE Sensex jumped by more than 2% on the announcement.

Exhibit 2: Indian rupee versus the US dollar (rupees for one US dollar) and the euro for the period from 06/2013 to 12/2014
Cuurency INDIA
Source: Bloomberg, BNP IP as of 19/01/15
Exhibit 3: S&P BSE SENSEX Index for the period from 2010 to January 19 2015

SENSEX Index (S&P BSE SENSEX Ind 2015-01-19 09-54-38

 Source: Bloomberg, BNP IP as of 19/01/15
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Paul Milon

Investment Specialist, Indian Equities

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