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India's central bank is on track for 'at least one more' rate cut, JPMorgan says

Key Points
  • J.P. Morgan Chief Emerging Markets Economist Jahangir Aziz said India's central bank is on track for at least one, or more, rate cuts in the near future.
  • The Reserve Bank of India on Thursday slashed interest rates for the third time this year.
  • Aziz also pointed out there is a major liquidity problem in India at the moment — especially in India's shadow banking sector — and that in the previous two rate cuts by the RBI, "very little has been transmitted to lending rates."
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Why JP Morgan says India needs to reduce its fiscal deficit

India's central bank is on track for at least one, if not more, rate cuts in the near future, J.P. Morgan Chief Emerging Markets Economist Jahangir Aziz said Friday.

The Reserve Bank of India on Thursday slashed interest rates for the third time this year.

The RBI cut its policy repo rate, or the rate at which it lends to banks, by 25 basis points (bps) from 6% to 5.75%. The central bank also changed its stance from neutral to an easing bias, otherwise known as an accommodative policy.

An accommodative policy implies that the central bank is trying to encourage spending by making it cheaper for companies and households to borrow, in a bid to foster growth in the economy.

India's central bank said in its monetary policy statement that external risks include the ongoing U.S.-China trade war as well as a slowdown in the domestic economy.

"The RBI has shown its easing bias, so whatever data that will come in, the RBI is going to look at it with those lenses," Aziz told CNBC's "Squawk Box " on Friday. "Therefore, our sense is at least one more cut — and maybe more, or more likely more."

Recent data showed a notable slowdown in growth for the January to March period. With a lower-than-expected 5.8% expansion for the quarter, India fell behind China's pace of 6.4% for the same period. At the same time, unemployment rate in the country is at a 45-year high.

J.P. Morgan is not the only one expecting more rate cuts in India.

Citi economists wrote in a note on Thursday that the RBI could deliver another rate reduction as early as August, and that the monetary policy committee members now appear to agree on the importance of stimulating growth in a benign inflation environment.

"Although the RBI changed the stance to 'accommodative,' we assess that there is room for one more 25bps rate cut in the Aug policy," they wrote, adding that rate cuts beyond that would depend on the "continuance of low inflation and low growth."

Meanwhile, ANZ Research economists predicted three more rate cuts of 25 basis points each over the next six months. "Given little room on the fiscal side we expect monetary policy to continue to do the heavy lifting to revive demand," ANZ economists wrote.

Liquidity issues

J. P. Morgan's Aziz pointed out there's a major liquidity problem in India right now — especially in the shadow banking sector.

He explained that by allowing the liquidity problem to fester in India's non-bank financial sector, the situation is increasingly turning into a solvency problem — which means it is becoming more of a matter of struggling non-banking financial companies and their ability to meet long-term debt and financial obligations.

An Indian naval officer walks past the logo of India's central bank, the Reserve Bank of India (RBI), in Mumbai on November 9, 2016.
Punit Paranjpe | AFP | Getty Images

In light of a banking crisis that slowed lending in India over the last several years, non-banking financial companies became important financiers to millions of small- and medium-sized businesses as well as individuals.

The crisis in the shadow-banking sector came to light when the Infrastructure Leasing and Financial Services, a major infrastructure financing and construction company, defaulted on its debt obligations multiple times, leading the government to intervene. Reuters reported that the company has a total debt of 910 billion rupees ($12.97 billion) and is trying to sell its assets to repay them.

More recently, the Indian unit of ratings agency S&P, cut the short-term credit rating of another non-banking financial company, Dewan Housing Finance Corp, to default. That prompted further concerns in the market.

"I think the need of the hour is to resolve the liquidity problem," Aziz said, adding that if the shadow banking sector issues turned into a solvency problem, then it could be a sizable one.

During a press conference, RBI Governor Shaktikanta Das said the central bank is "very closely monitoring" the situation in the shadow banking sector and that the RBI "will not hesitate" to take steps necessary for ensuring financial stability.