Mumbai: The Reserve Bank of India (RBI) said on Monday that both economic growth and inflation in the current fiscal are likely to fall below its earlier forecasts, a day ahead of its third quarter monetary policy review that’s expected by analysts and investors to cut policy rates.
In its Macroeconomic and Monetary Developments report, released on the eve of every quarterly policy review, the central bank said economic growth in the fiscal ending March is likely to fall short of its earlier projection of 5.8%. Inflation, as measured by the Wholesale Price Index, will continue to moderate and fall below its baseline projection of 7.5%, RBI said.
“The fact that they have mentioned about the slowing inflation confirms what the market expected, which is a 25 bps (basis points) cut tomorrow. But they have also mentioned the stickiness of inflation, which means that the depth and the pace of the cut will be limited,” said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd. “They have been objective enough about the issues in the economy, but we will wait for the policy announcement on Tuesday to gauge on how rates will move in 2013. So far we are expecting a 100 bps cut in 2013.”
While the central bank welcomed the policy changes made by the government since September and said these had reduced the immediate (macroeconomic) risk, “there is a long road ahead to bring about a sustainable turnaround for the Indian economy”.
RBI has resisted cutting policy rates, citing high inflation. The last rate cut was in April 2012, when the repo rate, at which the central bank lends to commercial banks, was lowered by 50 basis points (bps) to 8%. The market expects the central bank to cut its repo rate by at least 25 bps on Tuesday. A basis point is one-hundredth of a percentage point.
If there is a rate cut on Tuesday, banks may have to follow suit.
“We are favourably inclined to cut our lending rates (if there is a policy rate cut), but I am not willing to put a number or give a firm commitment before the policy,” said Bank of India chairman and managing director V.R. Iyer at a conference on Monday. “Our asset-liability committee will have to meet and evaluate the situation before taking a call on rates.”
Apart from the cut in policy rates, RBI lowered the cash reserve ratio (CRR) by 50 bps this fiscal after a steep 125 bps reduction in the fourth quarter of 2011-12. CRR is the proportion of deposits that commercial banks have to keep with RBI at zero interest rate.
The central bank has also pared the statutory liquidity ratio, or the mandatory bond holding limit of banks, by 100 bps to 23% of the deposit base in a bid to improve credit flows.
In other liquidity easing measures, the central bank has bought more than Rs.1.3 trillion of bonds from the secondary market so far this fiscal. The aim was to ensure that the banking system had enough cash for loans to industry as part of efforts to shore up the slowing economy.
Growth, however, remained subdued and fell to 5.3% in the second quarter from 5.5% in the first.
“The macroeconomic review confirms that we can expect a 25 basis points cut in the repo rate because they have clearly mentioned ‘continuation of the calibrated stance while increasingly focusing on growth risks’. Going forward, I think the RBI will look to match the government moves in removing obstacles like the fiscal deficit,” said Saugata Bhattacharya , chief economist at Axis Bank Ltd . “CRR cut is unlikely on Tuesday because they will like to save it for any surprises on structural liquidity or on the currency side. We are expecting a further 100 bps cut in repo in 2013.”
Growth is expected to stage a gradual recovery from the fourth quarter (Q4), aided by some revival in investment demand and the favourable effect of moderation in inflation on consumption, RBI said, adding that sustained recovery could be possible only if hurdles to business get removed.
“Though a modest recovery may set in from Q4 of 2012-13 as reforms get implemented, sustaining recovery through 2013-14 would require all-round efforts in removing impediments to business activity,” the report said.
As of 1 November 2012, out of 563 central sector projects of Rs.150 crore and above—largely concentrated in the sectors of road transport and highways, power, petroleum, railways, and coal—nearly half were reported to have been delayed. As a result, there were significant cost overruns in many of these projects.
The major reasons were delays in land acquisition, environmental clearances, project financing tie-ups, finalizing of engineering designs, lack of infrastructure support, change in scope and other contractual issues, RBI said.
Despite the policy changes since September that have seen the government allow foreign supermarket chains to open stores in India and let foreign airlines invest in domestic ones, business sentiment remains weak and consumer confidence is edging down. The government has also raised the price of diesel and capped the supply of subsidized cooking gas to households to pare its fiscal deficit.
“Fiscal risks have somewhat moderated in 2012-13, but a sustained commitment to fiscal consolidation is needed to generate monetary space,” RBI said.
The widening current account deficit, which reached a historic high of 5.4% in the second quarter of fiscal 2013, remains a constraint on monetary easing. It is expected to rise further in the third quarter, RBI said.
“While growth can be supported by monetary policy if inflation risks recede, credible fiscal correction with improved execution in infrastructure space to boost investment would be needed for a sustained revival,” the report said.
In this context, RBI will have to continue with its calibrated stance while increasingly focusing on growth risks, the report suggested.
RBI’s fight against inflation has yielded results, the central bank said, as prices started moderating in the third quarter. Core inflation pressures have receded markedly and “are unlikely to re-emerge quickly on demand considerations”, RBI said while cautioning there may not be any respite from high food and fuel prices that still remain a concern.
However, there is a suppressed element that poses “a significant risk” to inflation in fiscal 2013-14, the central bank said. “As some of the risks materialize, inflation path may turn sticky,” RBI warned in its report.
Inflation started easing from October last year, having been at more than 7% for most of the calendar year. In September, inflation was 8.07%, then slowed to 7.45% in October, 7.24% in November and 7.18% in December.
Various surveys show that business confidence remains subdued, with professional forecasters outside RBI revising down their growth estimate for the current fiscal to 5.5% from 5.7% earlier and growth for fiscal 2013-14 to 6.5% from 6.6% earlier.
The forecasters also raised their estimate for current account deficit sharply to 4.2% from 3.5% earlier. However, the same set of surveyors reduced their inflation forecast for the current fiscal to 7.5% from 7.7% earlier, RBI said.