The pressure is immense on Dr. Urjit Patel, who has taken over from Dr. Raghuram Rajan as the RBI Governor to cut policy rates in his first policy review on the 4th of October. Economic data that has come out recently reveals a lack of traction in the economy.
Financial markets reaction to a potential Fed rate hike next week would be the deciding factor for the RBI Governor. A negative reaction would put off rate cuts, as capital outflows would lead to currency volatility. A positive reaction will lead to a rate cut as the RBI can be confident of no adverse consequences if markets take Fed rate hikes in their stride.
The July IIP data and August trade data point to continuing weakness in the economy. IIP growth was negative year on year in July while exports and imports were down in August. Click here to read our analysis on IIP and Trade.
CPI inflation for August fell to five month lows of 5.07% on the back of falling food prices while core inflation was steady at below 5%. Click here read our analysis on CPI.
Global economic data too was weak with US retail sales showing flat growth in August while purchasing managers index for Japan and Eurozone fell. US job numbers for August disappointed expectations and the market is still divided on Fed rate hikes this month, though Fed officials are sounding hawkish. Click here to read our Global Economic Data Analysis.
Rate cut will add huge optimism to markets
Indian equity and bond markets are expecting rate cuts. Sensex and Nifty are trading at just a few percentage points off record highs while the ten year benchmark government bond yield is trading at seven year lows. There is optimism in equity markets as many factors are coming together to drive up equity valuations. Monsoons have been normal this year and rural demand is likely to rise. GST implementation is adding to optimism on tax revenues of the government. Guidance by managements in sectors of roads, cement, auto, select financial services, select pharma and healthcare, agricultural products and others are positive and markets are taking up valuations of stocks in these sectors.
Global liquidity is easy even though Fed is in rate hike mode with ECB, BOJ and BOE pumping in liquidity through QE. Read our note on Lack of bonds to buy amidst weak economic data for central bank QE analysis.
Bond markets too are factoring a period of low inflation expectations with oil prices staying ranged at USD 40/bbl. to USD 50/bbl. and with RBI buying bonds through OMO bond purchase auctions, supply fears have eased.
Rate cuts will take Sensex and Nifty to record highs and ten year bond yield to record lows.