RBI succumbs to low-flation

The Reserve Bank of India (RBI) cut interest rates by 25 basis points - repo rate to 6% (the first reduction in 10 months and the lowest rate since October 2010) and the reverse repo rate to 5.75% (reversing the 25 bps hike announced only four months before) - following its 2 August Monetary policy committee (MPC) meeting.

Financial markets widely expected the decision given India's deteriorating growth and inflation fundamentals. GDP slowed sharply to 6.1% in the year to the first quarter of this year from 7% in the December 2016 quarter while headline inflation decelerated from 2.2% (year-on-year) in May to a historic low of 1.5% in June - now below the bottom scale of the RBI's 4% +/- 2% inflation target range.

Recall that it was the accelerating pace of headline inflation and upside risks to it that prompted the RBI to raise the repo rate by 25 bps to 6% at its April 2017 policy meeting. That time, the central bank lifted its inflation forecasts to 4.5% in the first half of 2017 (from 4%) and 5% in the second half of the year (from 4.5%), with "upside risks to the baseline projection".

Not anymore. In its second bi-monthly statement (released in June), the RBI lowered its inflation projections to 2% - 3.5% in the first half of this year and 3.5% - 4.5% in the second half. This is largely on track with the June inflation figures putting average inflation for the first half of 2017 at 2.9%. The question now is whether the India's inflation would rebound to "a little above 4% by Q4" as the RBI expects.

At its August meeting the Indian central bank noted that "some of the upside risks to inflation have either reduced or not materialised."

The slowing growth outlook in the Indian economy suggests more downward pressure on consumer prices and raises doubts over the RBI's economic growth forecast of 7.3% for 2017/18.

The latest Nikkei India composite PMI output index fell sharply to 46 in July - contraction level - from 52.7 in the previous month. The manufacturing PMI dropped to 47.9 last month (the lowest level since February 2009) from 50.9 in June and the services PMI business activity index fell to its lowest level since September 2013 to 45.9 in July from 53.1 in June.

Moreover, the rupee's appreciation vis-a-vis the US dollar - up 6.6% this year to date - would compound the country's slowing growth and low inflation dynamics.

Read more: RBIrepo rateAugust MonetaryReserve Bank of IndiaNikkei India PMIreverse repo
Link to something S3oWG8lv