50 bps cut?
RBI affected the last rate cut in Oct 2016 expecting inflation to firm up gradually. Since February 2017 RBI has missed the inflation projection for Jan-Mar 2017 by 60 bps and for Apr-Jun 2017 by more than 2% (see table below). The Q4 FY17 inflation projection in Oct 2016 was 5% which closed at 3.57%. Given this backdrop, one can say that RBI should have cut rates may be in Apr 2017 or Jun 2017 itself. The inflation backdrop also suggests that 25 bps rate cut now is late and not enough. Therefore I would expect that with monsoon risks behind us, the case is ripe for a 50 bps cut on Wednesday 2nd Aug 2017.
USDINR view
A 50 bps rate cut would also ensure that debt inflows which is essentially hot money, doesn’t continue to flow in on the expectations of further 25bps rate cut in October 2017. Therefore a 50 bps rate cut would save the trouble of preventing INR appreciation for the RBI. Therefore I expect INR to appreciate into the policy and immediately after, where it could form a bottom till the time debt limits are raised. Target 63.75. CMP 64.15.
Needless to say a 50bps cut would be positive for equities and specially banking stocks.
On the other hand a 25 bps rate cut is priced in and should not result in large movements in any asset class.
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