RBI seen cutting interest rates in bid to spur growth

The Reserve Bank of India may cut interest rates by 25 basis points (bps) on Wednesday to boost growth as the government’s unexpected withdrawal of high-value banknotes is likely to hurt consumption, according to a Mint survey.

Eleven of 14 economists and bankers surveyed by Mint expect the monetary policy committee to reduce the benchmark rate by 25 bps at the monetary policy review. One expects a sharper 50 bps rate cut, while two economists think the rates will remain unchanged. A basis point is one-hundredth of a percentage point.

The government’s clampdown on high-value banknotes on 8 November has disrupted the cash-dependent supply chain of many firms, prompting economists to slash economic growth estimates for this year by as much as 330 bps. Combined with retail inflation slowing to a 14-month low of 4.2% in October, it has reinforced the belief that space has opened up for a rate cut.

“Growth has been weak; we had pencilled in a rate cut even before demonetization,” said Soumya Kanti Ghosh, group chief economic adviser at State Bank of India. “We expect November inflation to see a dramatic fall, to maybe around 3.5% and it could stay like that for three months. RBI will front-load the cut because once the deposit-taking is done by the end of this month, banks will push lending.” Ghosh was the only economist in the survey to predict a 50 bps cut.

In the October policy, the newly constituted monetary policy committee cut the benchmark repo rate by 25 bps. Minutes of the committee’s meeting showed that the panel was concerned about economic growth.

While demonetization has added to these concerns, other economists and bankers see merit in only a 25 bps cut at the upcoming review. “Demonetization is still going on and the rupee is under pressure,” said Harihar Krishnamurthy, treasurer at FirstRand Bank Ltd. “In any case, transmission in the form of falling MCLR (marginal cost of lending rate) and deposit rates is already happening separately.”

Since demonetization, the benchmark 10-year government bond’s yield has fallen 55 bps. While RBI has asked banks to temporarily increase the share of deposits parked with it, there is no dearth of liquidity in the system.

Rather, “there is no clarity on monetary behaviour. Banks are not clear if there will be a gain or net loss from demonetization. Until there is clarity there, RBI should not look at rates,” said N.R. Bhanumurthy of the National Institute of Public Finance and Policy. However, he still expects RBI to cut rates.

External sector concerns are another reason RBI should be cautious, said economists. The rupee has weakened 2.41% since 8 November, with Donald Trump’s win in the US presidential elections and a near-certain interest rate hike by the US Federal Reserve this month prompting investors to flee to dollar assets.

“The RBI will be watchful because of the creation of a risk-off environment which could engender volatile movement in the rupee,” said Rupa Rege Nitsure, group chief economist at L&T Finance Holdings Ltd, who expects RBI to maintain the status quo. “There are a lot of high-impact global events in December such as the Fed meet, Italy referendum, Brexit negotiations.”