Economic growth and receding deflationary pressure have signalled that India’s rate cut cycle is ending, said AllianceBernstein Asian sovereign strategist, global economic research, Anthony Chan.
In a recent report – India’s rate-cut cycle coming to an end – Mr Chan argued that India may raise rates as early as 2016.
“Moreover, the Reserve Bank of India (RBI) also strongly hinted at such a policy path after its 25-basis-point rate cut on 2 June ,” Mr Chan said.
Although policy efficiency under Prime Minister Narendra Modi and significant rate cuts – a cumulative 75 basis points since last year – have improved economic conditions, he said.
Mr Chan pointed out that the revision to India's historic GDP growth – of 200 basis points – has raised concerns that structural inflation may return.
“No one really knows the true level of the Indian economy’s potential growth rate after that abrupt revision, but we suspect that a recovery from the current pace can easily reduce any slack in India’s economy and result in a narrower GDP gap,” he said.
“This points to a re-emergence of structural inflationary pressure, typically caused by transportation bottlenecks and supply-demand imbalances.”
Mr Chan pointed out that the RBI’s official inflation target for 2017 is four per cent.
However, headline inflation and core inflation rates are currently sitting at approximately five per cent.
“So, strictly speaking, the central bank should be tightening policy to bring inflation down to four per cent if this is a more rigid, long-term target,” Mr Chan said.
“But as the recovery takes hold, accompanied by higher inflation, particularly if energy and other commodity prices also gather pace, the RBI may need to avoid negative real yields to make its longer-term inflation targets credible,” he said.
AB maintains the minority view that a rate hike is on the cards.
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