Active Stocks
Thu Mar 28 2024 15:59:33
  1. Tata Steel share price
  2. 155.90 2.00%
  1. ICICI Bank share price
  2. 1,095.75 1.08%
  1. HDFC Bank share price
  2. 1,448.20 0.52%
  1. ITC share price
  2. 428.55 0.13%
  1. Power Grid Corporation Of India share price
  2. 277.05 2.21%
Business News/ Money / Personal-finance/  RBI dilemma: Rate cut easier than rationale
BackBack

RBI dilemma: Rate cut easier than rationale

Reserve Bank of India's tough statements in the June monetary policy statement make it tricky for it to go a rate cut

Add the lower inflation rate to the argument of slack in capacity utilization and weak pricing power, to quote RBI’s own words, and the time looks perfect for a rate cut. Graphic: MintPremium
Add the lower inflation rate to the argument of slack in capacity utilization and weak pricing power, to quote RBI’s own words, and the time looks perfect for a rate cut. Graphic: Mint

At 6.25%, the Reserve Bank of India’s benchmark policy rate is at the same level when the country’s inflation rate was at least seven times higher than it is now. In the words of a former RBI governor, when the price of all commodities rises, so should that of money. Logically, the reverse should also be true. An all-time low retail inflation of 1.54% is reason enough to prune rates.

The deceleration of the past two months puts the inflation rate near the lower bound of the 2.0-3.5% forecast the central bank gave in the previous monetary policy. Put in the argument of slack in capacity utilization and weak pricing power to quote RBI’s own words and the time looks perfect for a rate cut.

It is no surprise that bond markets have priced in the 25 basis points rate reduction expected on Wednesday when the monetary policy committee (MPC) will release its policy resolution.

What could possibly thwart RBI from cutting the policy rate?

Firstly, RBI’s argument that a lack of transmission in the banking sector due to the stockpile of bad loans makes it futile to cut rates. But this argument is tenuous at best. Transmission hiccups are not new in India and banking channels have historically been inefficient. 

A repo rate cut is unlikely to make any difference to bond yields that have already dropped by a big margin. Yields could test lower levels simply because foreign investors cannot get enough of them given a stable currency and low inflation. The returns are too good to ignore compared with other emerging market economies. 

Second, real interest rates have surged because of the inflation fall and HSBC estimates that current real interest rates give RBI room to cut by as much as 75 basis points. Former governor Raghuram Rajan had said that the central bank would be comfortable with a real rate of 1.5%. But it is clear from the statement of current deputy governor Viral Acharya that RBI is not sticking to this rule and would be comfortable with a higher real interest rate.

Nevertheless, RBI’s tough statements in the June policy statement make it tricky for it to cut rates.

Even towards the June meeting, inflation had decelerated sharply, private investment was showing no signs of pick-up and oil prices also seemed at structurally low levels. But the central bank chose to wait for more data points. While it is unclear whether one more month of inflation will sway the central bank into cutting rates, the magnitude of fall in both core and headline inflation should add weight.

RBI could find it difficult to explain a rate cut as it could look like a flip-flop from its earlier statements. But it would also find it more challenging to justify a pause because that would mean RBI is looking through a 100 bps drop in core inflation in just two months and a depressed private investment in fear of factors that may not materialize. 

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 31 Jul 2017, 07:50 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App