India Policy Rate Cut to Have Minimal Credit Impact

rbi2Hong Kong/Singapore, Jan 20: The surprise decision by the Reserve Bank of India (RBI) to cut its policy rate by 25bps to 7.75% on 15 January, does not have a significant credit impact in the short term, says Fitch Ratings.

From the sovereign ratings perspective, achieving a credible, low inflation environment is a key factor for India, and the RBI is confident that the rate cut should not add substantial risks to achieving its 6% consumer price index (CPI) target by January 2016.

Falling commodity and food prices, and a gradual decline in long-term inflation expectations, have created a more benign inflationary environment in recent months, with CPI falling to 5% in December 2014. This made room for the policy rate cut. India’s central bank and government have taken steps to achieve sustainably lower inflationary conditions over the past year by adopting measures such as CPI-targeting and constraining food price growth by limiting the increase in the minimum support prices of agricultural products.

The rate cut also is expected to only have a modest effect on Indian banks. The banks are likely to lower lending rates due to the decision, and lower borrowing costs will provide some breathing space for highly levered corporates and sectors which have struggled with interest coverage amid slowing growth over the past several years. However, the extent to which this would have a long-term positive effect on bank asset quality remains uncertain.

If this rate cut suggests more monetary easing is coming though, then it is likely to lead to a sustained lowering of borrowing costs and potentially stronger bank asset quality. The extent to which the RBI will have more room to cut interest rates depends on domestic and external factors including inflation expectations, and commodity and food price growth. Whether the government presents a robust fiscal consolidation strategy and continues implementing structural reforms to ease supply pressures, particularly in the infrastructure sector, also are likely to influence future RBI decisions.

India is due to release its budget for the fiscal year to March 2016 by end February 2015, and that should give greater clarity on the country’s fiscal policy direction. India’s high public debt burden and deficit have been a long-standing key weakness for its sovereign credit profile. As such, the implementation of a clear and credible strategy to improve the country’s fiscal position would be credit positive.

//