Mumbai: Persistently high inflation and fears that it could rise even higher have forced economists and bankers to temper their expectations from the Reserve Bank of India’s (RBI’s) mid-quarter monetary policy announcement on 18 June. They say that any cut in the key interest rate will be restricted to 0.25 percentage point, or 25 basis points (bps).
Wholesale prices rose 7.55% in May, up from 7.23% in April and higher than the 7.5% predicted by a Bloomberg poll of 37 analysts.
Besides this, high core inflation and the revision of the March Wholesale Price Index (WPI) to 7.69% from a provisional 6.89% have led to economists becoming more circumspect than they were earlier.
Local money and equity markets reacted immediately after the inflation announcement. The yield on the 10-year, 8.79% government security maturing in 2021 rose from 8.29% to close at 8.33%, while the rupee fell from 55.66 to the dollar before the inflation announcement to end at 55.80.
Mint’s Joel Rebello says, a persistently high inflation have forced economists and bankers to restrict their hopes of a cut to just 25 basis points
The 30-share benchmark equity index, the Sensex, fell from 16,900 points before the announcement to end at 16,677.68, down 1.2%, while the 14-share Bankex fell from 11,611 points before the announcement to end at 11,338 points, down 2.82%.
The key interest rate is the repo rate—that at which RBI lends to banks in exchange for securities. In April, the central bank cut the repo rate by 50 bps to 8%, citing slower growth.
Core inflation (WPI manufacturing excluding food) inched up to 4.9% in May from 4.8% in April, indicating that demand-side inflation, which is the major worry for RBI, remains a problem.
Saugata Bhattacharya, chief economist at Axis Bank Ltd, said he expects only a 25 bps repo cut on Monday, down from 50 bps before the inflation numbers came out. “The upward revision in March numbers is the most worrying part because it means that inflation for April and May will most certainly be revised upwards, reducing any hopes of a deeper cut. I think RBI will await more numbers before cutting rates sharply,” he said.
Expectations of a 50 bps repo cut rose after data released on Tuesday showed industrial production remained almost unchanged in April at 0.01% because of a 16.3% drop in capital goods output.
Economists had previously expected the central bank to also cut the cash reserve ratio (CRR), or the amount of deposits banks keep with RBI, by at least 25 bps from 4.75% currently.
Sonal Varma, India economist at Nomura Financial Advisory and Securities (India) Pvt. Ltd, said she expects a rate cut to boost the economy. “Our view is that RBI will support growth by cutting the repo rate by 25 bps on 18 June (and by a total of 50 bps in 2012), but with no cut likely in the cash reserve ratio. Momentum in core inflation has not slowed sufficiently to warrant a 50 bps repo rate cut, in our view,” said Varma, who changed her expectations from a 50 bps cut after the inflation numbers were announced.
Yes Bank Ltd chief economist Shubhada Rao added that the tepid pace of investment growth, intensified global uncertainties and a correction in crude oil prices would provide RBI the grit to cut the repo rate by 25 bps with no CRR action.
India’s gross domestic product growth slipped to a nine-year low of 5.3% in the quarter ended March, raising fears of a prolonged economic slowdown and increasing expectations of more cuts by the central bank.
Economists now expect inflation to stay high. Nomura’s Varma expects WPI to remain above RBI’s threshold of 7% mainly due to high food prices after a 20% increase in the minimum support prices for kharif crops and a likely diesel price hike. “However, we expect core inflation to remain subdued due to the lagged impact of a wider negative output gap and lower global commodity prices in rupee terms,” Varma said, explaining why she expected a rate cut despite rising inflation.
Siddhartha Sanyal, India economist at Barclays Capital, also expects a 25 bps cut in the repo rate on Monday. He, however, expects deeper cuts in the rest of fiscal 2012-13 because he predicts core inflation will be contained below or around 5%, and weak fiscal health and the complicated political backdrop will bog down any growth-supporting initiatives from the government.
“With distinctly slower growth and contained core inflation, we have turned more confident of RBI cutting the repo rate in the coming months as well,” Sanyal wrote in his note after the inflation data was unveiled. “Threats of negative actions from rating agencies would constrain government’s spending to boost near-term growth, putting the onus of supporting growth more on monetary policy. We now expect RBI to rate cut the repo rate by 150 bps cumulatively during FY12-13, up from our earlier expectation of 100-125 bps.”
Bankers are, however ,looking for deeper cuts. B.A. Prabhakar, chairman and managing director (CMD) of Andhra Bank, expects a 25 bps cut in the repo rate as well as CRR. “I won’t be surprised if the rate cut is even 50 bps. Growth is slowing down sharply, while inflation is not very high. If rates are cut, we can see some activity in home loan, auto, retail and in SME (small and medium enterprise) segment dependent on interest rate-sensitive sectors,” he said.
Bankers are asking for a CRR cut because it will help free up cash, on which they do not get interest, that can be loaned at high margins.
Bhaskar Sen, CMD of Kolkata-based United Bank of India, said RBI will have to use a combination of monetary tools to “come out from this (economic) logjam”.
“We are expecting some announcement on CRR and cut in repo. The cut in CRR, up to 100 bps, may come in phases starting at 25 bps this policy review while repo could be cut by 25 bps. I don’t think that RBI would go for a 50 bps cut in repo again because in April it had already affected such a deep cut,” he said.
M. Narendra, CMD at Indian Overseas Bank, said he expects RBI to cut both CRR and the repo rate by 25 bps each. “CRR cut is the most important here given the liquidity condition. If there is a cut in CRR, the liquidity condition will improve and short-term rates will come down, which is better for economic growth at this point,” he said.
Since the annual credit policy announcement on 17 April, banks have borrowed on average Rs 98,300 crore from the daily repo window.
However, some such as Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, believe RBI will not change rates on Monday because of strong risks to inflation and as core inflation is unlikely to come off significantly in the near term.
“Slower growth is essential to keep a lid on inflationary expectations in the economy given the loose fiscal stance. We believe it would be prudent for RBI to sit on the sidelines at the moment and pass the ball into the government’s court to act on reviving investor demand and thus stabilizing growth,” Pan wrote in a note dated 13 June.