RBI credit policy: RBI wary of CAD; hope for 25-bps cut: Credit Suisse

Robert Prior-Wandesforde of Credit Suisse explains on CNBC-TV18 that though the markets may tank if the RBI leaves interest rates untouched, the chances of a zero cut in rates are higher than a 50-bps cut. However, Wandesforde believes that a 25-bps cut is the most likely outcome. The expert also highlights the underlying tug-of-war between the government and the RBI on boosting growth and the implementation of the fiscal measures to control the rising current account deficit (CAD).

Below is an edited transcript of the prognosis on CNBC-TV18 Q: The RBI report on Monday was a bit contradictory. Though it estimated that core inflation pressures would not re-emerge, nothing else in the document seemed to suggest that the Reserve Bank of India (RBI) was very keen on cutting rates. What did you make of it and what do you expect to see today?
A: That is right. The statement was in some ways surprisingly hawkish. I also think that the RBI’s comments in that statement were a little naughty in some ways. One comment complained about the quality of the fiscal adjustments. I thought was slightly strange. That there has been some fiscal adjustment in itself is a surprise though the government has been unable at this stage to do anything on the revenue side.
Secondly, the idea that inflation is going to be pushed higher by diesel prices is again a little bit naughty, because the RBI has been pushing incredibly hard for the government to do exactly what it has done. Nevertheless, that was the statement.
The suggestion was possibly a 25-bps cut on cash reserve ratio (CRR) and we will obviously wait and see whether Subbarao springs one of his famous surprises. I just hope that if it is a surprise it is not a zero cut in rates. Under those circumstances, the market would tank and Chidambaram would clearly not be a happy man either. Q: What are the risks? How high is the probability, after looking at Monday's document, that he actually chooses to pause and does something only after the Union Budget?
A: Based purely on that document, I think the chances of a zero cut in rates are higher than a 50-bps reduction. But I still sense that a 25-bps cut is, by far, the most likely outcome. There is still reference to growth risks and reacting to those growth risks, albeit in a calibrated manner, which was a word that was used throughout that statement. So I think it would be a major surprise if we did not see something.
If we do get the widely anticipated 25-bps move, obviously all the focus will be on that statement and the extent to which Subbarao is prepared to hint at further rate-reductions to come.
According to my very dovish long-term view, we need to see inflation surprise on the downside. We need to see a tough Budget and we need to see a meaningful improvement on the current account. I think all of those will come through, but it is a question of time. Q: There was quite a bit of reference to the current account deficit (CAD) situation, something not really seen in the past in these reports. What did you make of that?
A: I think that is right. That was a new and an interesting factor. If we think about it, most of the news since the RBI’s announcement of policy on October 30 and December 18, has been positive. There have been downside inflation surprises, not least on core. The RBI expected inflation to move up. But it has actually moved down with core inflation at 4.2 percent.
The finance minister clearly has taken more initiative than anticipated. So the RBI’s focus had to be on something new and negative i.e. the current account position. One can understand and sympathise with the fact that it is going to be difficult to finance the CAD over the long-term and probably it is in part, structural.
If one believes that the level of commodity prices is structurally higher then inevitably it means that India’s CAD is structurally higher as well. But I suspect that even that hurdle will diminish over time. I think we have not seen the lagged positive effects of the weakness in the currency as a boost to net exports. I think that will occur over the following months resulting in at least some narrowing in CAD and hopefully it will allay fears a little bit. Q: Do you think the RBI is genuinely worried about parameters like CAD and consumer price index (CPI) inflation and therefore indicating that it will not be able to move? Or is it rather a case of tempering market and government expectations?
A: I think it is probably a bit of all of those things put together. Subbarao tempered expectations a few weeks ago and again last week suggesting limited room to manoeuvre. This brings to the fore an undercurrent of a tug-of-war between the government and the RBI. Chidambaram is obviously keen to do as much as he possibly can to persuade the RBI to cut and to try rates and engineer some growth through monetary policy rather than through fiscal policy.
Clearly, the RBI at least in the statement is not prepared to give the finance minister much benefit of doubt. The central bank wants to see increased initiative from the government and wants to see the measures being implemented. The RBI seeks a Budget that is not too loose. I don’t this the tug-of-war is particularly healthy game and shows a lack of trust between these two key policymakers. But nevertheless, that seems to be the reality.