BackRate cut for sure but by how much, Dr Raghuram Rajan?
Will RBI governor Raghuram Rajan go for a 25 bps cut in repo rate or do a repeat of September with a deeper 0.5 percentage point cut?
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All economists in a Mint survey expect Reserve Bank of India (RBI) to cut its policy rate on 5 April.
The debate has been on the quantum of cut: will RBI governor Raghuram Rajan go for a quarter percentage point cut and bring down the benchmark repurchase or repo rate, at which commercial banks borrow money from the central bank, to 6.5%? Or, will there be a deeper 0.5 percentage point cut?
There is a clamour for a cut in banks’ cash reserve ratio (CRR) too against the backdrop of tight liquidity in the banking system.
There were days when the daily liquidity deficit in March was as much as ₹ 2.5 trillion.
At least some bankers believe that there could be a quarter percentage point rate cut, combined with a cut in CRR. Banks need to keep 4% of their deposits with RBI in the form of CRR; they do not earn any interest on this.
There are many reasons for RBI to cut the policy rate.
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First, the consumer inflation in February moderated to 5.18%, way below consensus estimates, driven primarily by lower food inflation even as wholesale price inflation remained in the negative zone for 16 months in a row, touching -0.91% in February, against -0.9% in January. A few analysts expect consumer inflation to slow to about 4% in the coming months, and it will probably remain in the range of 5-5.1% in early 2017, broadly in sync with RBI’s inflation target.
Second, factory output contracted 1.5% in January, worse than consensus expectations, and weaker than the 1.3% shrinkage in December. In November, it had contracted by 3.2%, the sharpest in the past four years.
In January, the growth in consumer durables dropped considerably, consumer non-durables declined and capital goods, considered a proxy for investment demand, contracted sharply.
Clearly, the industrial growth momentum has been faltering. This is not only supporting the call for a rate cut but it may also prompt RBI to lower its growth projection from 7.6% to 7.5% for the current fiscal, with downside risks.
Third, US Federal Reserve’s decision to keep the interest rate unchanged (all 10 members of its policy-making body Federal Open Market Committee’s voted in favour of that), and its apparent dovish stance—despite the fact that Fed has said risks are now evenly balanced between economic weakness and inflation—will also be an influencing factor.
The stance of Fed’s monetary policy remains accommodative, and by saying “the degree of the strengthening in final demand over coming quarters, an essential element in sustained economic expansion is still uncertain", it has made quite clear that the time of the next hike and pace of further hikes are in no way round the corner. In fact, in the past few months, central banks around the globe have turned more genial even as growth impulses by and large have remained weak.
Finally, by sticking to the path of fiscal consolidation and keeping the fiscal deficit target at 3.5% of India’s gross domestic product in 2017, the government has created the space for a rate cut. In the February monetary policy statement, Rajan said: “Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for the monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5% by the end of 2016-17."
Even though at this point everybody isn’t convinced about the government’s ability to generate enough revenue to meet the fiscal deficit target, a staggered implementation of the Seventh Pay Commission recommendations and reforms in agriculture and change in norms of the public private partnership model for infrastructure are certain important aspects of the Budget which RBI is unlikely to ignore.
The government has also lowered the interest rates on various small savings schemes, including public provident fund and Kisan Vikas Patra, and aligned them with market rates. From now on, interest rates on these schemes will be reviewed every quarter and not annually. This will ensure better transmission of monetary policy.
Typically, commercial banks are slow in cutting their deposit rates even after RBI pares its policy rate for fear of losing deposits to the small savings schemes run by the government. Now, with interest rates on such schemes being market-linked, banks will be in a better position to cut deposit rates and, eventually, loan rates.
Now the question is: Will RBI go for a quarter percentage point cut or do an encore of its September 2015 policy when it surprised the market by a half a percentage point cut to bring down its policy rate to a four-year low of 6.75%? That was the fourth cut since January 2015 when the policy rate was 8%. At that time, Rajan had committed himself to maintaining an “accommodative" stance and said the focus would be to work in tandem with the government to “ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed".
Since the market has already factored in a quarter percentage point rate cut, unless RBI cuts the policy rate by half a percentage point to 6.25%, Tuesday’s policy will be a non-event. However, that does not mean Rajan will go for a deeper rate cut even though it cannot be ruled out entirely.
The bigger probability is, however, a quarter percentage point rate cut now and a repeat once the central bank gets a feel on the trajectory of the monsoon which will have a bearing on food inflation. With the fear of El Nino receding, the monsoon is expected to be better this year than previous two years. While a good monsoon will have a positive impact on food inflation, worry remains on the inching up of the so-called core, or non-food, non-oil inflation, at this point.
Meanwhile, the new concept of marginal cost-based lending rate or MCLR that kicked in on 1 April will also be a test of monetary transmission.
The chances of a cut in CRR, combined with the rate cut, look slim even though the banking system faced a severe liquidity crunch in March. Net of selling, RBI bought bonds worth at least ₹ 54,000 crore in the last fiscal year to infuse liquidity in the system through its so-called open market operations.
High government cash balances with RBI and currency with the public or the money in circulation partly contributed to the cash deficit. Besides, RBI has not been buying dollars from the market in the past few months. When it buys dollars, an equivalent amount of rupee is released into the system and that adds to the liquidity.
With government spending picking up in the first quarter of the new fiscal, liquidity tightness is expected to ease.
There are other ways of adding to liquidity. For instance, the government’s surplus cash kept with RBI can be auctioned periodically. The Chinese central bank periodically does so as part of the finance ministry’s cash management programme. Agence France Trèsor, the debt management agency of Banque de France too invests surplus cash in the inter-bank market in the form of unsecured loans. RBI can also raise the limit of banks’ daily borrowing from the central bank through its repo window which is at present capped at 0.25% of their deposits. Similarly, it may also bring down the limit of daily cash balance of 95% that banks need to keep with it for CRR which is currently pegged at 4%. Unless RBI foresees severe liquidity crunch to continue in the new fiscal year, it will not cut CRR at this juncture.
One thing is for sure: the Indian central bank’s accommodative stance will continue even as future actions will depend on data, both internal and global.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of Sahara: The Untold Story and A Bank for the Buck.
Comments are welcome at bankerstrust@livemint.com.
His Twitter handle is
@tamalbandyo
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