Investors in India, enjoy the first interest-rate cut of a fresh easing cycle. It has been long awaited, but it is finally here. More importantly, it signals confidence on the part of the Reserve Bank of India (RBI) in the government's ability to keep the fiscal side of things in check.
This is remarkable for a country with a somewhat long tradition of witnessing its central bank and its government at loggerheads.
The quarter-of-a-percentage-point cut in India's repo policy rate to 7.75% came unexpectedly, ahead of an official monetary policy meeting due to take place on Feb. 3 and after the central bank held fire on interest rates at a meeting last year in December.
The Sensex stock market index jumped, closing 2.66% higher on the news. All the 12 sector indices on the BSE ended the day higher, with real estate the star performer, surging by 7.99%, the Economic Times newspaper reports.
It looks like India has entered a Goldilocks phase of its economy, helped by the sharp fall in the price of oil, but also by a government elected last year in May that seems determined to push through reforms.
The world's most populous democracy has always struggled with high inflation and the fact that it is now contained enough to allow the central bank to relax monetary policy is no small feat.
December's wholesale prices index (WPI) inflation was just 0.1% year on year, according to data released on Wednesday, much lower than market expectations of 0.4%. The fuel and power component, which has a 15% weighting in the basket, fell by 7.8% year on year, massively helped by the fall in oil prices.
But other components of WPI -- such as manufactured products, with a 65% weighting -- eased too, with the pace of price rises nearly halving to 1.6% vs. 3% a year ago.
This "reinforces a sustained disinflationary backdrop" and raises hopes for further rate cuts, says Commerzbank's Asia analyst Ashley Davies. He expects a cut of maximum half a percentage point this year, depending on prices remaining low and a stable global backdrop.
The rate cuts could go even deeper than that. Shilan Shah, India economist at Capital Economics, expects the RBI to slash its policy rate by a total of three quarters of a percentage point this year, to end 2015 at 7%. He believes Thursday's rate cut was partly motivated by the recent rally in the Indian rupee (INR), which has strengthened by nearly 2% against the U.S. dollar since the beginning of January.
The falling global oil prices should keep inflation in Indian fuel prices in check, even as the government raises taxes as part of measures to strengthen the fiscal stance, making the case for further cuts easier.
The economy could use the support, noted Shah. In the third quarter, GDP growth slowed to 5.3% year-on-year from the second quarter's healthier 5.7% growth.
The country's trade deficit saw a remarkable improvement in December, when it narrowed to $9.4 billion from November's $16.9 billion, almost all due to oil. But export growth has remained disappointing, contracting by nearly 4% -- a sign that the government should do more to revive export prospects, Shah said.
The Indian rupee (INR) strengthened immediately after the RBI's announcement, which is highly unusual for a currency having to deal with an interest-rate cut. But the strengthening is justified by the fact that in the emerging markets sphere investors are really liking oil importers right now, and the central bank's move supports growth.
The RBI's easing is likely to be beneficial for equity inflows, but also for foreign demand for fixed income, according to Jason Dew, an analyst with Societe Generale.
"The INR remains one of our top picks in Asia in 2015 due to manageable current account deficit, acceleration in growth coupled with a lower inflation profile, ongoing foreign portfolio inflows and attractive risk-adjusted carry," Dew said.
