Shishir AsthanaMoneycontrol Research
The guessing game on whether or not the RBI will cut its key policy rate is an old one. This time around -- hold your breath -- it is going to be no different. But what will give the six-member Monetary Policy Committee (MPC), which will meet on February 7-8, a real hard time to call, are the equally compelling arguments for and against moving the needle on the repo rate.
Finance Minister Arun Jaitley in his Union Budget speech dropped a subtle hint that the banking regulator could look at lowering the rate. Trigger: the government reduced the net market borrowing to Rs 3.48 lakh crore from Rs 4.25 lakh crore. But, let’s not forget that for the central bank, government borrowing is just one key metric which it will watch.
Analysts are expecting the central bank to lower interest rates given the huge liquidity build-up in banks on account of demonetisation. However, industry body like FICCI feels that the RBI will stand pat at 6.25 percent.
Broking firms Nomura and Deutsche Bank feel that the MPC will propose a 25 basis points (bps) cut. Bank of America is more optimistic and feels that RBI will be more aggressive throughout the year and can even announce a 50-75 bps cut in the first nine months.
But analysts have a convincing case for a rate cut. Consumer prices measured by CPI cooled to a two-year low of 3.4 percent in December. This could nudge the six wise men on the committee to recommend a cut.
With inflation well within its expected limits, the RBI might shift its focus to growth, which has taken a hit thanks to the cash replacement drive. Various economists, rating agency and international bodies have cut India’s growth rate. Economic growth for this fiscal year has been lowered by 25-50 basis points compared to the baseline growth assumption of 7 percent. Now that the Budget is out of the way pressure will be on the central banker to help push India’s growth.
A data point which might tempt the RBI to cut rates is the abysmal non-food credit growth that has fallen to a multi-decade low of 4 percent. Even if Patel, appearing in his third policy review, errs on the side of caution and holds rates, given the volatile international scenario, he can pump liquidity through LAF (liquidity adjustment facility) window or open market operations (OMO). This could act as a proxy for interest rates reduction while giving the central banker more leg room to manoeuvre.
The market will want to know whether the banks will pass on the rate cut, if one comes along? In all likelihood, the banks may not. With more money coming in owing to demonetisation, the banks have already announced severe cuts in their lending and bulk deposits rates by up to 90 basis points and 125 basis, respectively. In so doing, they have managed to meet the RBI’s rate cut in October last year.
While domestic liquidity is a positive trigger, global factors are adding to headwinds. Oil prices have started moving higher and interest rates in the US are also expected to move north sooner than market expectations.
Nomura Securities in its report has said that even though they expect a rate cut, it would be a close call for the governor. Considering the fast changing dynamics and volatile situation after China increased short term interest rates on Friday it would be a close call on rate cuts.
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