Rate-cut is not viable; cut only to cheer mood: Experts

A select panel of experts comprising Chetan Ahya, chief economist and managing director, Morgan Stanley, SS Mundra, executive director, Union Bank, Sanjay Nayar, country-head, KKR India and Ajit Ranade, chief economist, AV Birla Group agree that a cut in interest rate by the RBI would not boost growth and called for a small reduction to cheer market sentiment. CNBC-TV18 also announced the conclusions of an exclusive poll of on what the financial markets have priced in.

Below is an edited transcript of the conclusions of the poll and the discussion on  CNBC-TV18.

There is almost a war cry out there for a rate cut.  A CNBC-TV 18 poll indicates that 80 percent of the market expects a CRR cut of and of this, 20 percent expects a 50-basis point cut.

On the repo rates, the market is divided with 50 percent calling for a repo rate cut.  Importantly, 40 percent of the bankers, economists and fund managers polled expect RBI to cut both CRR and repo on October 30 when the RBI announces its credit  policy.

For the full fiscal year, the majority expect further cuts in repo rate after the announcement policy on Tuesday. Around 75 percent expect another round of reduction of 25-50 bps in repo rates after October 30, while only 25 percent expect no cut or expect RBI to stop with a 25-bps cut on Tuesday.

On CRR too, the market expects a further round of cuts. Around 40 percent expect a total cut of 50 bps in CRR including a cut on Tuesday, 10 percent expect a 75-bps cut, 20 percent expect a 100-bps cut and a miniscule 5 percent expect a CRR cut by as much as 150 bps.

Growth is likely to grab the RBI's attention for the rest of the year and the majority expect the RBI to sound more dovish on growth than before, shifting focus away from inflation. That explains why close to 70 percent of the respondents expect RBI to revise its GDP growth forecast downwards to below-6.5 percent and only 30 percent expect GDP forecast to be retained at 6.5 percent.

On inflation, the market remains divided whether RBI will revise its inflation forecast from the current 7 percent.

Q: You represent a big business group which along with vendor and suppliers, almost constitutes a mini-economy. What is your opinion? Are the rates so high that industry is actually not able to produce?

Ranade: The logic behind tightening rates lies in its use a means to control inflation. If you look at last three years, the growth rate of GDP has come down from 8.5 percent to 6.5 percent and perhaps this year it is 5.5 percent. Whereas, the average inflation rate for the WPI base has come down from 9.6 percent to 8.8 percent and 8 percent, which means that the tightening has had a much more disproportionate impact on GDP than on inflation. So, that's fact number one.

Secondly, the economy is dangerously close to a situation where the productive capacity is being significantly reduced by these so-called supply bottlenecks which also include tightened rates and a slowing GDP. So the very tightening of rates has slowed down the process of capacity-creation.

Gross fixed capital formation, which is an indicator of capacity-creation, has really rapidly come down and of course, private-sector investment spending is down to very, very low levels. Add to this, the cost of interest as a proportion of EBITDA or profitability, has increased significantly. In fact, in three years when interest rates were tightened by roughly 170 percent, interest outgo was up by almost 300 percent. So therefore the tightening has been considerable.

Please remember that ultimately, the mandate is not a single mandate, it is a balance between growth and inflation. One does recognize that there are inflationary concerns, but I think there a virtuous cycle could be triggered. A cut now will induce inflows which will make the rupee stronger like the announcement of reforms in September. Finally, there is the impact of interest rates on deficit as interest constitutes a large part of deficit.

Q: You publicly stated that inflation was led by demand. Would you agree with the view that rates have reached a level where it has started to actually choke supply?

Ahya: There is no free lunch in a macro-economy. If real interest rates are negative then you do not incentivise the households and the system to save enough. The current account deficit is almost close to 4 percent of GDP. So, there is increased pressure from the market to loosen interest rates. If real interest rates turn negative when expectations on inflation are high, it will only fan the inflation expectations further.

So I think, great care should  be taken before deciding on the solution rather than just using the typical remedy which has worked in the past in India. But whenever growth has slowed in the past, there has been a big decline in inflation and the cuts in interest rates made perfect sense.

But in the current situation when the slowdown in growth has not had the resultant effect on inflation, a cut in interest rates is not the solution. The key is to independently implement measures which augment supplies. I think all participants in the economy forget that the component, about 20 percent CAGR, of very high rural wages over the last three-and-a-half years is playing an independent role in impacting inflation.

Similarly, the fiscal deficit of 9 percent of consolidated GDP has resulted in the transfer into the hands of households which, in many cases, is less productive. So I think there is a need to formulate a comprehensive solution independently from tightening interest rates.