Impractical for RBI to cut rates given inflation: CLSA

The central bank yesterday painted a gloomy picture for the economy by lowering its GDP forecast for FY13 and indicated higher inflation risk.

Below is an edited transcript of his interview with Udayan Mukherjee.

Q: Do you think any surprise is possible or is the room for surprise is very limited this time around?

A: I think very much the latter. Bear in mind that in the last few months whenever the RBI has actually surprised one could always make some kind of a case for some behind the scenes remote control operation as such. April was the most surprising bit when RBI cut by bigger than expected 50 basis points while the flavor in the policy statement actually indicated that it perhaps would have preferred to stay on hold as such.

At the same time, don’t forget the change of guard as far as the Ministry of Finance is concerned. So when you go back and think about late last year when RBI was cutting rates while lot of the rhetoric from Ministry of Finance was to cut rates, obviously there was some backing that RBI was getting. So my own sense is this time around the room for surprise is practically not there because I think the broader pressure points are understood far better and political compulsions are much less pressing.

Q: Contrarians who are betting on a rate cut this time around point out that because of the monsoon issues growth might have become an even bigger problem and that maybe something that the RBI may choose to focus on this time around. It’s not consensus, it’s not even a majority view, but what is your contention on that point?

A: It misses the basic point that given where inflation is it is just not practical or sensible for RBI to cut rates. We have seen growth in India slow down from 9% to 5%, and along each point a similar argument was made. Industry lobby groups keep on making that point. What is often overlooked is really at the end of the day the level of interest rate has to be appropriate, both as far as depositors and borrowers are concerned. But bulk of the argument from industry is always on the borrowing cost perspective.

At the same time if you cut rates when inflation in any case has not been compensated by the level of deposit rates, you are only going to increase more stress in the system. So I think that kind of an argument cannot necessarily be completely dismissed because depositors are important and deposit mobilization has actually been rather weak.

Q: If the RBI were to cut repo rates today, do you think it might actually confuse the market given what it said the last time around? It might even not be seen as a very credible move because it would be going against what it itself said a few weeks back?

A: I think it’s already lost a fair amount of credibility, which is precisely why if it were following its own guidance it should actually stay on hold. In the last year or so we have seen variety of different metrics used by RBI. Initially the focus was on core, then it moved to food, then it was headline, then it was consumer price inflation. It’s perhaps understandable why that move has been there given that quality of data as far as inflation and a reliable CPI only started coming out earlier this year.

But I think from the April rate cut onwards there have been far greater questions about credibility, which is why six weeks ago when RBI stayed on hold it was perhaps the first time in a long time that one got the sense that they were once again gaining ground in terms of having a more consistent framework. For exactly that reason I think it’s more appropriate for them to stay on hold rather than cut and still be worried about inflation.

Q: What about the CRR? Is it completely out of the realm of possibility given how liquidity trends have been of late?

A: Six weeks ago they didn’t cut CRR, and liquidity conditions are actually better now then they were back then. So to me despite what bankers in India always keep talking about CRR I don’t think there is really a strong case for it.