RBI likely to go for a 25 bps rate cut
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Mumbai: The Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) may cut interest rates by 25 basis points on Wednesday after retail inflation hit a record low in June, economists say.
Of the 15 economists surveyed by Mint, 11 expect the central bank to cut the repo rate—the rate at which the central bank infuses liquidity in the banking system—by 25 basis points.
A basis point is one-hundredth of a percentage point.
“At the August 2 meeting, we expect the RBI to cut rates by 25 bps but maintain its neutral policy stance,” said a Morgan Stanley report dated 26 July.
The Indian economy has been struggling. India GDP growth rate slowed to 6.1% in the March quarter because of demonetisation and credit growth to companies has slowed to a trickle as banks are weighed down by a pile of bad loans. The June quarter earnings data now also points to a slowdown in some sectors ahead of the introduction of the goods and services tax (GST) on 1 July.
At the previous bimonthly monetary policy review, the MPC had kept the repo rate unchanged at 6.25% but lowered its inflation forecast to 2-3.5% for the first half of 2017-18. However, since then, inflation has continued to cool.
With June’s 1.54% print, inflation as measured by the consumer price index (CPI) has fallen below 2%, the lower end of the MPC’s target range of 2-6%. The central bank has a medium-term target for CPI inflation at 4%.
To be sure, the future inflation trajectory plays a more important role in the MPC’s decision making than previous data points. According to the June policy minutes, Michael Patra, RBI executive director and part of the six-member MPC, had said the focus must not be on conducting monetary policy by looking at “the rear-view mirror (the most recent inflation prints)” but towards the medium-term inflation target.
Most economists say the inflation readings are unlikely to exceed the medium-term target any time soon. This is even after considering the reversal of the statistical base effect, which had lowered the recent inflation number, and other risk factors such as seasonal uptick in vegetable prices and implementation of housing rent allowance (HRA) for government staff and GST are factored in. Separately, risks to inflation are also emanating from the worsening fiscal situation because of farm loan waivers, RBI governor Urjit Patel had warned in June.
Some economists say it is prudent to wait for these factors to play out rather than going for monetary easing in August.
There is a case to cut rates in October, according to IndusInd Bank chief economist Gaurav Kapur. By then, there would be a clear picture on the short-term impact of GST introduction on growth and inflation, as well the implementation of HRA, especially by state governments. Additionally, there would also be clarity on the surplus liquidity in the banking system, he said.
RBI is draining out excess liquidity, which had led to falling cost of borrowings for most companies, by conducting so-called open-market operations, where it sells government bonds.
The decision-making in the MPC is unlikely to be unanimous, going by the minutes of the previous meeting, according to economists. MPC member Ravindra Dholakia, a professor at the Indian Institute of Management, Ahmedabad, had called for a 50 basis point cut in June. However, he was outvoted by the other five members.
Viral Acharya, RBI deputy governor and MPC member, had also questioned whether an RBI rate cut would really help economic growth at a time of bank balance sheet stress, according to the minutes.
“Tolerance for a slightly higher real rate of interest is justified to ensure weak banks do not find relatively low the hurdle rate for ever-greening of bad loans. What is required for monetary policy to do its job better is to address the stress on bank balance sheets,” he wrote.