India likely to cut policy rate by up to 50bps

But monetary policy easing will be delayed until inflation decelerates.

According to Morgan Stanley, given the RBI’s policy guidance and its expectation that improvement in macro stability indicators from their elevated starting point will only be gradual, it expects limited room for further monetary policy easing. 

It adds that an additional 25-50bps of policy rate easing in the rest of CY 2013 can be expected. We believe that full transmission of the monetary policy easing will be delayed until the time CPI decelerates meaningfully. 

Here's more:

We believe that full transmission of the monetary policy easing will be delayed until the time CPI decelerates meaningfully. 

We believe that since the credit crisis, the economy has been afflicted by weak macro trends because of the continued high fiscal deficit and low investment spending (what we characterize as bad growth mix). We believe that this bad growth mix is at the heart of the macro stability risks of high CPI inflation, trade deficit. 

Since September 2012, the government has taken clear steps to alleviate the bad growth mix, and that has led to early signs of a reversal in the stagflation type environment. Fiscal consolidation is being delivered and the government will likely stay the course going into F2014. 

Fiscal consolidation is positive for the economy – it helps to bring about improvement in macro stability risks such as CPI inflation, the current account deficit, and deposit growth. 

Moreover, the moderation in rural wages, after almost five years of acceleration, will also help to lower food production costs and bring about a moderation in food and hence overall inflation. We believe that fiscal consolidation and moderating India, the largest bank in the country, hiked its deposit rate by 25 bps and cut its lending rate by just 5 bps as deposit growth remains below credit growth.

We believe that in the near term the transmission of today’s policy rate cut will also lag given the weak deposit growth trend and elevated credit-deposit ratio. 

For instance, if we assume credit and deposit growth at current levels, the credit-deposit ratio will continue to move up on a seasonally adjusted basis.