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Why Further Rate Cuts Are on the Horizon for India

India's central bank may be downplaying speculation of further rate cuts after its aggressive 50 basis point cuton Tuesday, but some analysts believe the Reserve Bank of India (RBI) is not done yet, calling for additional cuts of up to 75 basis points for this year as the country struggles to boost growth.

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“The central bank was reluctant to signal that it has embarked on a series of rate cuts, although we continue to believe, that, that is what will eventually materialize,” Robert Prior-Wandesford, Director, Asian Economics at Credit Suisse told CNBC.

He believes both growth and inflation will “surprise the central bank to the downside,” triggering further monetary policy easing.

“A further prolonged period of sub-trend growth in India - the trend rate is 7-7.5 percent - should put downward pressure on underlying inflationary pressures,” he said. He is expecting the repo rate, currently at 8 percent percent, to fall by another three-quarter point by year-end.

India’s growth rate slowed to 6.1 percent in the fourth quarter of 2011 compared with a year earlier, its weakest annual pace in almost three years.

Sameer Goel, head of Asia rates and currency research at Deutsche Bank, agrees that further cuts are on the cards, forecasting a further 50 basis point cut by year-end.

“I think the RBI has left the room open for potentially some more rate reaction. There was already, before this policy meeting, about 90-100 basis points of rate cuts priced in over the next 12 months,” Goel said. “I think the market will build a consensus of 1-2 more rate cuts.”

Their dovish views are in contrast to the central bank’s more hawkish outlook. Following the RBI’s half a percentage rate cut, doubling analysts' consensus estimate and its first in three years, Governor Duvvuri Subbarao warned that there is limited space or further reduction, pointing to inflation risks. The central bank is due to hold its next policy meeting in June.

But Prior-Wandesford argues that the RBI is “over-doing” some of the inflation concerns, pointing to the fall in core inflation to 4.7 percent in March from 8.2 percent last November. Core inflation tracks price levels of all items other than food and energy.

“Given the on-going weakness in key international commodity prices, such as metals, core inflation should continue to trend down,” he said.

Cyrus Daruwala, Managing Director for IDC Financial Insights, agrees that fears about rising costs are overhyped and says he wouldn’t be surprised if the RBI embarks on further rate cuts. “The rate of inflation is bearable, I didn’t think India had runaway inflation figure to begin with. Inflation is under control,” he said.

Daruwala adds that the latest move by the RBI will help prop up investor sentiment in the lackluster stock market environment.

“The move will buy the RBI a quarter of positive sentiment,” he said. The 50 basis point cut has created an immediate liquidity pool of $2 billion, according to Daruwala, a sizeable amount for a market largely driven by retail investors.

India’s benchmark Sensex ended up 1.3 percent, while the NSE index gained 1.2 percent.

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