Thanks to the FED and low inflation, the RBI will cut once more before India’s elections

The Fed’s capitulation in late December has opened space for Asian central banks to focus on the region’s soggy growth. Even India, which boasts the highest growth rates in the region, slowed to 6.6% YoY in Q4. The good news is that slowing inflation and a dovish Fed gave space for the RBI to cut rates in February 2019 – shifting its policy stance from “calibrated tightening” to “neutral”. We believe that it is a move that the central bank will repeat this week with another cut of 25bps to take the repurchase rate to 6%. Across the region, price pressures have been falling rather rapidly on the back of weak growth. For India, the slowing CPI trend started in 2018 thanks to decelerating food price pressures. That said, the RBI could not cut rates to ease financial conditions as the Fed was hawkish in 2018. India’s tight monetary environment also called for easing of conditions in 2018 but the RBI’s hands were tied. But no longer - our Natixis Monetary Condition Index ( NXMCI ) shows that monetary condition eased for India after the RBI’s 25bps cut in February. But it is too tight and among the most restrictive in Asia, driven by a very high real interest rate (RIR). On a RIR basis, India ranked the second place in tight monetary stance, only slightly lower than Malaysia’s. Given India’s growth slowdown, RBI is expected to release more support for the economy, just in time before the elections. And the support will prove timely as Prime Minister Modi will be judged for the economic progress for his tenure since 2014. With the deceleration as a setback for Modi as well as weakness in employment promises despite strong progress in capital liberalization, in the short-term the upcoming elections means that the government is doing everything it can to boost lending and support growth. In this spirit, a cut seems especially likely since the upcoming RBI meeting is just shy of the national election. Beyond monetary policy, Asian governments will also turn to Master Keynes for guidance and India will deploy its limited fiscal space to where it most need the votes. Given the slow progress of urbanization, which means most of the voters are still rural, the RBI has been under pressure to help in easing liquidity conditions not just via interest rate cuts but also transferring the central bank’s excess capital to the state for to support rural workers. Modi has also backtracked on some reforms such as ecommerce to appease to retailers, who are key in the upcoming elections. Our analysis of Modi progress report shows that he has made some progress in attracting capital and reforming the banking sector. That said, should Modi be successful at getting re-elected, more work is needed - In dia needs to attract 2% more of GDP than it current does to leverage its excess labor supply to absorb much needed capital and close the financing gap.