India's central bank takes a dovish turn

  • India’s central bank has unexpectedly cut interest rates by 25 basis points to 6.25%
  • Ahead of national elections, the cut is likely to come under scrutiny for political motivations
  • We now expect rates to stay on hold until the second half of the year

The Reserve Bank of India (RBI) delivered a surprise rate cut under its new governor this morning, and changed its stance from ‘calibrated tightening’ to neutral. The move will please Prime Minister Modi and his ruling BJP, who replaced the more hawkish former governor Patel with governor Das in December last year. Given this recent appointment, and coming as it does ahead of national elections in May, the cut will unfortunately come under scrutiny for potential political motivations.

A pause would have been the more prudent option, in our view. While it is true that headline inflation continues to fall, with the latest print just 2.2% year-on-year, this is driven by food prices which are in contraction. Meanwhile, core inflation continues to rise and the recent fiscal budget announcements sound quite inflationary. There is no guarantee that oil and food prices will remain helpful either.

We think a cut may have been warranted later in the year, had growth struggled. Waiting would also have given a sense of the likely direction of fiscal policy; a more populist government after the May elections would warrant a more hawkish central bank, for example. We would therefore expect rates to be on hold from here until the second half of the year, but given that the bank has revealed a preference for dovishness, a further cut in April would not totally shock us.

India's interest rate since June 2000