Rajan rate surprise prompts bullish forecast shift

[NEW DELHI] A surprisingly early start to India's rate- cutting cycle prompted at least four global banks to step up forecasts for further easing this year.

Reserve Bank of India Governor Raghuram Rajan lowered the repurchase rate to 7.75 per cent from 8 per cent yesterday in the first cut since May 2013. Barclays Plc sees the benchmark at 7.25 per cent by June, 25 basis points lower than its earlier forecast. Morgan Stanley, Commerzbank AG and Australia & New Zealand Banking Group Ltd. also shifted outlooks. The one-year interest-rate swap rate extended declines after dropping the most since October yesterday.

While signaling that the RBI is confident of achieving its target to limit consumer-price gains at 6 per cent by January 2016, Rajan also said the government needs to stick to fiscal goals to justify more easing. The 10-year sovereign bond yield will fall 44 basis points to 7.25 per cent by Dec. 31, according to the median estimate of 10 banks and money managers in a Bloomberg survey. The repo rate is seen dropping to 7 per cent.

"Given the huge improvement in India's inflation dynamics, driven by a collapse in oil prices, the central bank will have more room to cut," Charlie Lay, a strategist at Commerzbank in Singapore, said in a phone interview yesterday. "On the back of reduced rates, we expect the rupee to be stable and yields to come off more." The rupee climbed to its strongest level since Nov. 13 yesterday amid confidence the government will complement Rajan's action by addressing infrastructure bottlenecks that boost living costs and act to spur Asia's third-largest economy. The currency rose 0.3 per cent to 61.8625 a dollar today.

Finance Minister Arun Jaitley, likely to present the budget next month, has pledged to narrow the fiscal deficit to a seven- year-low of 4.1 per cent of gross domestic product.

"Key to further easing are data that confirm continuing disinflationary pressures," Rajan said in a statement. "Also critical would be sustained fiscal consolidation as well as steps to overcome supply constraints and assure availability of inputs such as power, land, minerals and infrastructure." Rajan's move came after a Jan. 12 report showing consumer prices rose 5 per cent in December, holding below the RBI's 6 percent target for a third straight month. India, which imports about 80 percent of its oil, benefited from a 48 per cent slump in Brent prices last year. Rajan raised the repo rate three times since taking office in September 2013.

Morgan Stanley expects the RBI to cut the repo rate by another 125 basis points over the next 12 months, compared with an earlier estimate of 50 basis points. Commerzbank sees a 100- basis point reduction in 2015 from 50 earlier. ANZ, which previously saw the rate dropping 25 basis points this year, is now predicting a decrease of up to 75 basis points more.

Prime Minister Narendra Modi's government has scrapped controls on diesel prices, raised natural gas tariffs and allowed more foreign investment in sectors such as defense since taking power in May. It last month decided against extending a tax break for the local automobile industry in a bid to bolster revenue and meet its deficit goal.

While the RBI cited the government's commitment to meeting the target in its statement yesterday, the shortfall had reached 99 per cent of the full-year target in just eight months, data showed Dec. 31. Growth in the US$1.9 trillion economy slowed in the July-September period for the first time in three quarters.

"The RBI will be enamored towards substantial easing only when the government is able to show meaningful progress on cutting the deficit and removing supply constraints that push prices higher," Kunal Kundu, an economist at Societe Generale SA in Bengaluru, said in a phone interview yesterday.

Bond Outlook Investors are predicting more gains for Indian sovereign debt, which returned 16.5 per cent in 2014, the most among the largest emerging markets including Brazil, Russia and China.

Barclays forecasts the 10-year sovereign yield at 7.25 per cent by year-end, compared with an estimate of 7.40 per cent earlier. The rate was little changed at 7.69 per cent today, after slumping eight basis points yesterday, the most since Dec. 2. It tumbled 97 basis points, or 0.97 percentage point, last year, the most since 2008, as calls for easing intensified.

The cost of locking in borrowing costs for a year slid five basis points today to 7.50 per cent, the least since July 2013, data compiled by Bloomberg show. Its 10-basis point drop yesterday was the steepest since Oct. 20. The rate sank 70 basis points last year.

The "earlier-than-expected rate cut clearly shows that the RBI's bias has shifted sharply towards easing," Mitul Kotecha, head of Asia-Pacific currency strategy at Barclays in Singapore, wrote in a report yesterday. "The statement was dovish in our view and with the disinflationary trend being strong, we see room for a further rally in government bonds."

BLOOMBERG