A 25 basis point (bps) cut in the repo rate, at which the Reserve Bank of India (RBI) lends overnight funds to banks, is what most economists bet on when governor Raghuram Rajan unveils the central bank’s bi-monthly monetary policy on Tuesday. One bps is one hundredth of a percentage point.
That is a fair expectation since the consumer inflation has shown consistent downward trend in the recent months and US Federal Reserve has given a breathing space to RBI to act on the rate-front.
But most likely, Rajan is unlikely to heed the calls from the North Block for a bigger dose of rate cut since there are factors that feeds the fear of potential resurgence in inflation. Among them, a weak monsoon and its impact on food prices tops the list. This shouldn’t let the RBI to gamble with a surprise cut this time.Secondly, there is a possibility of consumer inflation accelerating beginning September as base effect fades. On a higher base last year, inflation will seem lower this year even though the quantum of increase will be identical and vice-versa.
Third, it is better if the RBI chooses to take the plunge now rather than later as it is likely that the global financial markets may be in the grips of panic if and when the US Federal Reserve finally raises key rates. A sharp drop in the RBI’s key rates and an increase in the US Fed’s interest rates can be catastrophic since this could result in sudden flight of capital across the border.
Fourth, under the agreement signed between the RBI and government in February this year, the central bank has to hold inflation below 6 percent by January 2016 and reduce it further to below 4 percent by January 2018. This would logically make the central bank more cautious on further monetary accommodation.
In a note released on 25 September, rating agency CARE even bets for a status-quo in rates on Tuesday. “There is a strong reason to keep rates unchanged considering that the concerns that the RBI had in the August policy linger even today,” CARE said.
“In fact the additional information we have is of the Kharif crop being less than last year, which will exert pressure on prices.”
CARE also cites the wearing off of a favourable base effect, the Fed factor, currency volatility and negative portfolio investments as supporting reasons for a status-quo. India witnessed foreign portfolio investment outflow of 2.6 billion dollars in the April-June quarter, marking the biggest quarterly outflow in six quarters.
But, the status-quo theory is unlikely to hold since there is indeed a consistent decline in consumer price index (CPI) inflation in the recent months. CPI inflation, which stood at 5.4 percent in June, fell to 3.69 percent in July and subsequently 3.66 percent in August.
On the other hand, wholesale price index (WPI) inflation, has been declared dead long back.
Being in negative territory for more than ten months, WPI doesn’t pose any immediate cause for concern. Rajan can certainly take credit for containing inflation and the government can thank lower crude and commodity prices internationally for setting the stage for lower inflation.
So far this year, Rajan has cut interest rate by a cumulative 75 bps. The point is that these rate cuts haven’t fully translated into lower interest rates for the end-consumer since banks have cracked balance sheets and capital scarcity.
Of them, state-run banks, which constitute 70 percent of the banking industry, are severely hit for both reasons.
These factors, coupled with, over-leveraged balance sheets of corporations, lessens the chances of any immediate pick-up in credit growth even if the RBI cuts the repo rate by another quarter percentage point.
In the past, the RBI has expressed its concern on lack of policy transmission in the banking industry and has listed this as one of the major conditions for effecting further rate cuts.
“As the Reserve Bank awaits greater transmission of its front-loaded past actions, it will monitor developments for emerging room for more accommodation,” the central bank said in the August bi-monthly policy review.
Finance minister Arun Jaitley has been making a strong case for a rate cut from the RBI to aid economic recovery, so are the government’s economic advisor Arvind Subramanian and NITI Aayog chief Arvind Panagariya. In all likelihood, Rajan will heed to those calls with a small dose of rate cut. But, that’s likely to be the last one in this round.
2015 Kashmir Despatch