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RBI will also be concerned about the lack of monetary policy transmission even after two surprise inter-meeting rate cuts. Photo: Reuters
RBI will also be concerned about the lack of monetary policy transmission even after two surprise inter-meeting rate cuts. Photo: Reuters

Samiran Chakraborty|Pause before easing further

RBI might defer the next rate cut and wait for more preconditions to be met

It is likely that the Reserve Bank of India (RBI) will continue using relatively accommodative language in the April monetary policy meeting, a process it started in January 2015. Given our expectation that the consumer price inflation will average around 5.4% in FY16 and assuming that the central bank is comfortable with a real policy rate of 150-200 basis points (bps), there is scope for 25-50 bps more rate cuts. However, consecutive inter-meeting rate cuts in January and March have made it difficult to forecast the exact timing of the next rate decision.

The guidance provided by RBI in the policy statement after the rate cut in March nudges us to believe that the repo rate might be left unchanged in the April policy, though measures to improve monetary policy transmission could be considered. The list of preconditions outlined by RBI as necessary for further monetary action is a long one and it might not have enough new information on these after their its March decision.

On the positive side, the bills related to coal and other minerals have been cleared by both Houses of the Parliament, paving the way for improved availability of power. Also, oil prices are down about 10% from the day of the last repo rate cut and global markets have breathed a sigh of relief as the US Federal Reserve signalled that the first rate hike might not be imminent. So, there has been some progress on both these preconditions.

However, on others, the progress has either been slow or not enough new information is available. Important amendments to the land acquisition bill are facing stiff opposition and it is uncertain how much concession the government will have to make to get it passed in the Upper House. It is probably too early to judge whether any material change is happening on the quality of fiscal adjustments at both the central and state levels. The first official forecasts for monsoon would only be known by late April. In fact, anecdotal reports suggest that the unseasonal rain in March might have already caused vegetable and food prices to spike in some parts of the country. So, if RBI wants all preconditions to be met before reducing rates further, then it might have to wait a little longer.

RBI will also be concerned about the lack of monetary policy transmission even after two surprise inter-meeting rate cuts. This is another precondition suggested in the March policy statement on which developments have been rather tardy. Banks have been reluctant to reduce their base rates and even the market-linked rates have not responded much. The yield on the 10-year government bond is almost unchanged from where it was before the first rate cut in January and corporate bond yields have responded only marginally. One can argue that the markets had factored in rate cuts from RBI even before the easing started and the banks will start reducing their base rates from April when the credit demand eases. If one believes this explanation, then RBI could wait in the April policy to find out the extent of transmission before acting again. However, if RBI is keen to see a faster transmission, then it can consider some liquidity easing measures (Cash Reserve Ratio or Statutory Liquidity Ratio cut) or even nudge the system through another 25 bps rate cut. A CRR cut to infuse primary liquidity will definitely indicate urgency to bring rates down.

Another reason for a repo rate cut in April could be persistence of weak growth numbers. RBI mentioned in the March statement that it is appropriate “to be pre-emptive" to “utilise available space for monetary accommodation". If RBI wants to hasten the growth recovery or make the most of the available window before the Fed starts hiking rates, then front-loading the planned rate cuts could be an option.

However, we feel that with March consumer price inflation likely to be higher for the fourth month in a row, RBI might defer the next rate cut and wait for more preconditions to be met. We expect more rate cuts once improvements in supply constraints convince us that food inflation is structurally lower.

The author is head, South Asia macro research, Standard Chartered Plc.

This is the second in a series of three articles by economists ahead of the Reserve Bank of India’s bimonthly monetary policy review on 7 April.

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