The markets cheered the Reserve Bank of India’s surprise rate cut – but why did they cut now, and in an unscheduled meeting?
The Reserve Bank of India (RBI) surprised with yet another unscheduled rate cut overnight. The rate was lowered by 25 bp to 7.50% and was cheered by financial markets. The SENSEX gained nearly 1% reaching a record high and swap rates are as much as 20 bp lower. INR is flat, but outperforming on a day when EM currencies are broadly weaker.
Easing was expected, but why now and why in an unscheduled meeting?
Why now? The RBI is a “politicised” central bank. By this we mean that it has a direct dialogue with the central government. It tries to influence the fiscal side by explicitly conditioning further monetary easing on the budget performance. So it appears as if the RBI is rewarding the government for its recent budget agreement. In this regard, Rajan stated, “welcome intent to shift from spending on subsidies to spending on infrastructure, and to further reduce and better target subsidies through direct transfer.” In our view, the budget was neutral on balance, relative to expectations. It failed to cut the deficit as much as some had hoped, but it did come with large spending promises. If the outlined investments materialise, it will be positive, but implementation is a well-known problem in India.
Separately, Prime Minister Modi has granted central bank governor Rajan his year-long request for an explicit inflation target. This is an important medium term step for the institution. Even though the current stewardship lacks no credibility, it will ensure long-term continuity of this policy.
Why in an unscheduled meeting? This is a harder question to answer. The easiest answer is that Rajan wanted the decision to be closer in time with the budget announcement and the change in mandate to an inflation targeting regime – again, a reward system of sorts. The other option could be that Rajan wants to use the surprise effect to get an extra bang for his buck. Perhaps he knows that high inflation will constrain how much the bank can ultimately ease, so he is relying on the expectation channel to increase the impact of these moves.
Going forward, we still see an overall favourable environment for Indian assets, especially equity and fixed income. We think the rupee is in a good position to still outperform many of its peers in the EM space, but in outright terms, the currency will still be moving with the vagaries of the broad dollar trends.