Bet on lower inflation, vote for growth

Written by fe Bureau | Mumbai | Updated: Apr 18 2012, 12:42pm hrs
Home, auto & corporate loans set to be cheaper

Surprising markets and industry, the Reserve Bank of India (RBI) on Tuesday cut the key repo rate by 50 basis points, bringing it down to 8% and effectively signalling a turn in the rate cycle. However, the central bank was quick to add that the scope for further rate cuts was limited, saying while the deviation of growth from its trend is modest, the upside risks to inflation remained. These considerations inherently limit the space for further reduction in policy rates, RBI said in its annual monetary policy statement.

RBI governor Duvvuri Subbarao later said at a press conference: The space for further cuts is limited, but it is not as if there is no scope. Also, if the growth-inflation dynamics change in either direction, we will change our stance. The RBI, which has projected inflation at 6.5% by March 2013 and a GDP growth of 7.3% for the current fiscal, believes reduced pricing power in the economy will help contain inflation as and when there are hikes in fuel prices. The risk of adjustments in administered prices translating into generalised inflationary pressures remains limited, though there is no room for complacency, the central bank noted.

Home and auto loans are expected to come down, though bankers did not commit to an immediate rate cut.

Yield on the benchmark 10-year bond fell to 8.35% from 8.57% ahead of the announcement and the Sensex added 207 points by the end of the day. Explaining the RBI stance, which had seemed positively hawkish in the annual review released on Monday, Subbarao justified the 50 bps cut, pointing out that growth had decelerated significantly to 6.1% in the third quarter, though it was expected to have recovered moderately in the last three months. Based on the current assessment, the economy is clearly operating below its post-crisis trend, Subbarao said, highlighting that headline WPI inflation, as well as non-food manufactured products inflation, had moderated significantly.

Concerned over a spurt in gold imports, the RBI asked banks to reduce exposure to NBFCs lending against the precious metal.

It has set up a working group to suggest ways to deal with the issue.

The central bank has also asked banks to set up internal exposure limits for non-banking financial companies who have gold loans portfolio of more than 50% of the total financial assets.

Bankers believe loan rates would be brought down though they were not immediately sure by how much and how soon, given that deposit rates needed to be lowered before lending rates could be cut. Said Pratip Chaudhuri, chairman State Bank of India: Loan rates should come down because even the entire impact of the lower CRR hasnt taken place yet. But rates cannot come down across the board; we will need to see where we can adjust the mark-ups. Added Chanda Kochhar, CEO and MD ICICI Bank: We should see a fall in lending rates but deposit rates have to come off and banks are facing a challenge in raising deposits and a part of this challenge is in the pricing.

Governor Subbarao believes that monetary transmission should be effective. A cut of 50 bps is a strong signal. Moreover, the cut in the CRR of 125 bps has brought down funding costs for banks and they have additional access to the market stabilisation fund. However, I cant indicate how exactly it may be choreographed. The governor added that money supply or M3 growth had been projected at 15% for the current year and non-food credit growth at 17%. It should be possible for both the government and the private sector to borrow, Subbarao observed.

Following up on its cuts in the cash reserve ratio (CRR) of 125 bps since January this year, aimed at providing more liquidity to banks, the RBI has allowed banks to borrow 2% of their net demand and time liabilities under the marginal standing facility(MSF), which would attract a rate of 9%. The RBI cautioned that any slippage in the fiscal deficit will have implications for inflation. Going by the recent burden-sharing arrangements with the oil marketing companies (OMCs), the budget estimate of compensation for under-recoveries of OMCs at the present level of international crude prices is likely to fall significantly short of the required amount, the central bank said.