HSBC sees inflation below RBI's 2017 target, room for rate cut

Inflation is likely to remain below the Reserve Bank's early 2017 target of 5 per cent for the next 12 months, opening up space for monetary easing, says an HSBC report.

According to the global financial services major, the declining trend in inflation is expected to continue as new crop streams into the market and CPI inflation could fall to under 4.5 per cent in January-March 2017.

Moreover, vegetable prices are expected to completely reverse their summer ascent and higher pulse production may reduce inflation by another 40 bps.

"RBI has two objectives – to reach its 5 per cent inflation target in early 2017 and keep real rates at the 1.5-2 per cent range. Marrying the two would open up space for easing by 50 bps," HSBC said.

HSBC expects a 25 bps rate cut at both December and February policy meetings.

The next policy review meet is scheduled to be held on October 4.

It will also be the first review under new RBI Governor Urjit Patel, who has assumed charge effective September 4, after the end of his predecessor Raghuram Rajan's three-year tenure.

Though there are some good reasons for a rate cut in the upcoming October 4 meeting, yet HSBC's base case is for a rate cut in December rather than October.

"This is because, by December, two new inflation prints, which are expected to be well below 5 per cent, will be available," the report noted.

According to HSBC, the commentary on the October meeting would be "dovish" and the central bank is expected to continue infusing liquidity into the banking system by buying dollars and government bonds.

"Our estimates point to a balance of payments (BoP) surplus of USD 25 billion in 2016-17, and given the possibility of currency leakage to the tune of Rs 2.5 trillion this year, we expect bond purchases to continue at a rapid clip, given that RBI wants to move closer to its aim of closing the rupee deficit," it said.

The second half of 2017 may see some policy-related upside risks to inflation such as the second round effect of the government wage hikes and a temporary hardening of inflation if GST rates are over 18 per cent.

"In light of these risks and RBI's desire to eventually move towards the mid-point of the 4 per cent (+/-) 2 per cent band, we expect the 50 bps rate cuts to be the last in the cycle," HSBC said.