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Unconventional Rate Cut Opens Pandora’s Box for India Watchers

Anirban Nag and Ronojoy Mazumdar

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The Reserve Bank of India’s decision to cut interest rates by an unprecedented 35 basis points has made it more difficult for investors and analysts to predict the next move of the central bank that’s already known for pulling surprises.

The magnitude of last week’s cut adds another challenge to India-focused economists, who until now had to deal with dodgy official data to make forecasts. For investors, it adds a new layer of uncertainty.

“We not only have to grapple with some questionable data, but now have the additional challenge of trying to predict rate moves that are beyond convention,” said Priyanka Kishore, head of India and South East Asia Economics at Oxford Economics. “It just makes the task of forecasting rates and economic trends rather onerous.”

Governor Shaktikanta Das defended the move, which took the benchmark rate to a nine-year low of 5.40%, as a “balanced” measure to provide stimulus to the economy. A half-point would have been “excessive” and a 25 basis-point cut would have been “inadequate,” he said last week.

Surprises Galore

The departure from the conventional moves -- multiples of 25 basis points -- leaves the door open for more surprises from the RBI, which has a history of catching investors on the wrong foot.

The RBI was last year rated by Bloomberg Economics among the top central banks that surprises the most. India ranked third when it came to surprises, according to the study, which looked at all central bank decisions from Group of 20 countries from 2010 to 2018.

China, Russia, India and Brazil on average surprised 25% of the time, according to Bloomberg Economics’s Tom Orlik and and Justin Jimenez. Unsurprisingly, central banks tend to surprise more around leadership changes and shifts in policy direction, they wrote.

Under Governor Das, who was brought in after his predecessor Urjit Patel abruptly quit in December, the RBI cut rate and abandoned a ‘calibrated tightening’ stance for a neutral bias in the first policy meeting he helmed in February. The Monetary Policy Committee eventually adopted an accommodative stance.

The uncertainty could hurt especially if the rationale behind the offbeat rate moves isn’t communicated properly by the central bank, analysts said. For example, after the 35 basis point cut Wednesday, 10-year bond yields rose as investors judged that future rate cuts would not be deeper.

“These rate changes have to be clearly explained to the market, otherwise it could be confusing and yields could go up instead of down,” said Soumya Kanti Ghosh, chief economic adviser at State Bank of India in Mumbai.

For economists, too, it will be more of a punt, rather than an informed opinion.

“The risk for analysts is it’s very difficult for us to predict a 15, 35, 50, or a 55 basis point cut going forward,” said Madhavi Arora, an economist at Edelweiss Securities in Mumbai. “In that sense it has opened up a Pandora’s box of guesswork for the street.”

To contact the reporters on this story: Anirban Nag in Mumbai at anag8@bloomberg.net;Ronojoy Mazumdar in Mumbai at rmazumdar7@bloomberg.net

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Karthikeyan Sundaram

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