DBS Bank: RBI likely to hold rates in October, easing expected by year-end: Radhika Rao

My opening statement was framed as a question to you. We have seen a stimulus blitz take place in China, which was much needed to revive the Chinese economy. Over the past week or so, we’ve seen this aggressive stimulus in action. But where do you think this leaves us in relation to China now?
Radhika Rao: Certainly, what stood out in China’s measures this time was the urgency and the wider range of options, spanning from rate cuts to property measures. We should remember that in recent quarters, the Chinese government has introduced various supply-side measures aimed mainly at lowering the cost of financing. But now, the tone is more urgent, and there is talk of additional consumption-focused measures and bank recapitalization. These combined actions from the government and regulators reflect the seriousness of their stimulus efforts.

Regarding India, there are concerns in the markets that portfolio rebalancing could favor undervalued Chinese stocks, contributing to some hesitation in price movements. However, much of India’s gains in equities have been driven by strong retail participation, which remains closely tied to domestic markets. India’s growth, in my view, has been largely driven by domestic demand—especially investment spending from households, the government, states, and parts of the private sector. Thus, the developments in China are unlikely to significantly impact India’s growth trajectory.

We should also keep an eye on the commodity space, particularly minerals and metals that India imports. Price fluctuations in these areas could affect our import bill. While China is currently on holiday, it will be crucial to see how much of the stimulus measures materialize once they return, as this will influence market sentiment and optimism for both China and the broader region.

With India’s MSCI weightage increasing, how might this impact future portfolio flows into Indian markets, especially given the renewed optimism surrounding China?
Radhika Rao: India’s weightage in the MSCI Emerging Markets index has risen and is on a convergence path with China. In the world IMI index, India’s weight has also increased, surpassing China’s to some extent. From what I hear, investors have entered Indian markets based on its strong growth profile and macroeconomic stability. This attractiveness won’t be diminished by China’s stimulus.

However, investors who view the region as a whole may seek opportunities in undervalued Chinese markets, which have underperformed compared to India. Some reallocation is happening, but India’s high retail participation offers a buffer against shifts in foreign investor appetite. Long-term investors are unlikely to be swayed purely by short-term developments in China. Yesterday, we received several pieces of economic data regarding India. The current account deficit for Q1 FY25 showed a widening trend, and core sector data for August came in at -1.8% versus 6.1% in July. How do you interpret these figures?
Radhika Rao: The core infrastructure index for August was indeed weak, with declines across most sub-sectors. Weather conditions likely played a role in this slowdown, as the erratic monsoon impacted output. Comparing April to August of FY25 with the same period in FY24, output has generally slowed, except for electricity. We should monitor the second half of the fiscal year to better understand the trend. Additionally, reports of steel dumping in local markets and the government’s investigations into these claims could be dampening output.Regarding the current account deficit, while it has widened slightly, we expect it to remain manageable at around 1% of GDP for FY25. The goods trade deficit will be wide, but lower energy prices may help contain the import bill. Foreign direct investment (FDI) and portfolio flows are expected to provide strength on the financing side, helping maintain a balance of payments surplus. India’s foreign reserves are at record highs, providing a crucial buffer against any adverse movements in the currency.

I once again want to have your take on the kind of flows that India could be expecting, because at one point India’s portfolio inflows have been strong, but the rupee remains an underperformer. So, what factors are driving this disconnect between the strong inflows and a weaker currency? And how do you see this trend evolving in the near term?
Radhika Rao: It is certainly very important to watch. I think that disconnect has been playing out for quite a while where even when we have pockets of very strong inflows the currency has not really reacted as much. We saw that during the period also when the dollar was rising. You had seen a lot of the Asian currencies, for example, ASEAN currencies as well weaken very sharply, especially if it is Malaysian Ringgit, Thai Baht, Korean Won. We had seen them underperform. At that point, the rupee was in fact one of the regional outperformers, because it was held relatively stable because of active intervention efforts.

And on the way down, which is that the dollar is now softening, many of the ASEAN markets have made up for lost ground. But the rupee has been stable. It is now the regional underperformer. So, that disconnect has been playing out and I think that disconnect can be explained by two reasons. So, the first one is, of course, the authorities lookingto correct rupees outperformance on the real effective exchange rate basis, that is rupee vis-a-vis its trading partners, is it at competitive levels, that is first.

And the second one is, of course, the reserves. Like we discussed earlier, reserves have risen from strength to strength and I think policymakers, given the kind of backdrop we are in, see reason in strengthening defences. And we should remember that reserves also are coming because of flows. These are not current account surpluses. These are by flows. So, they do see reason in strengthening that defence as much as possible. I think this has contributed to the currency’s underperformance. Looking ahead, our base case is that dollar will continue to soften and if that is the case rupee would also likely strengthen, but it is going to be relatively marginal compared to some of its regional peers.

I cannot not ask you about what about the interest rate cycle back home because we have the Federal Reserve went ahead with the bumper 50 basis point rate cut, though you had commentary yesterday coming in from Powell, which was a bit of a hawkish one where he said that we will have to wait and take it easy when you talk about the future rate cuts, but what is your take back home? MPC will be meeting next week. What are your expectations? What have you all pencilled in when it comes to the interest rate scenario or interest rate cycle back home?
Radhika Rao: Certainly, what the Fed did, I think it is a necessary but not sufficient reason for the RBI to go ahead and ease rates urgently. I think the governor has made it quite clear that India will act on domestic reasons. Fed does matter, but it will be overridden by what domestic considerations are. At this point, rest of this week we are really waiting for one important announcement, which is that who the new external members for the MPC would be.

I think they would sit in for the upcoming meeting. Once their names are announced, I am sure the markets will glean through what the stance of each of these MPC members are, so that is the kind of backdrop that the RBI has on hand. Domestic inflation had eased in July, August. RBI knew that was coming, they had highlighted that they would look through it.

So, inflation well behaved, but likely to pick up. New MPC members and the Fed that has acted, but acted on the domestic reasons on their front and RBI will act on its own domestic justification. So, putting these three things together, we do think that October meeting would be more to maintain status quo. We would be very interested in hearing the commentary of whether the RBI sees reason in sounding less hawkish. Inflation overall, in our mind, is still trending lower. Fiscal 25, it is settling into a new lower range so that we think should satisfy the central bank insofar as we are closer to the target that they see reason in gradually easing. So, we do see rate cuts coming, but we do not think that will kick start in October’s meeting. I think it will be closer to the year end, which is end 2024.