Column: A rate cut seems unlikely

Written by Madan Sabnavis | Updated: Jul 31 2014, 07:55am hrs
The concept of credit policy has evolved over the years with a metamorphosis in thought, content and direction. Traditionally, we have had two policies with a slack and busy season that coincided with the harvest, and festival season when there was more spending by consumers that, in turn, increased demand for funds by industry for production. This distinction was contested and done away with towards the end of the 1990s. RBI did reserve the right to intervene to correct markets and there was business for economists and treasury analysts as they tried to guess RBI action based on economic and monetary conditions.

A couple of years ago, RBI decided there would be eight policies to reduce the noise in the market and make things more predictive. But when there was the forex crisis last year, interventions brought in some correction. The latest stance is there will be six policies with the right to intervene when required. But the direction seems to be clearly on reducing uncertainty in the markets as when players start to guess every time, they tend to create distortions.

The content of policy has changed. There was a time when the policy document touched on every aspect of the financial system and there were sections on bank lending, prudential regulation, market development, ULBs, etc. It was a comprehensive review and way forward for the entire system. This has also been dispensed with as RBI has separated all reforms and financial sector issues from monetary policy. The credit policy is now just a call on monetary policy measures with other issues being flagged separately through discussion papers and draft and final reports. Thus, the content is to be focused on rates and measures to control the growth in credit and in the true sense is a monetary policy statement.

The approach to monetary policy has changed too. Going by the textbook, policy is to target a tradeoff between growth and inflation and economists have argued all their lives in favour of one of them. If you followed the classical economics doctrine, then inflation-targeting would be preferred. If the dogma was Keynesian, then the die would be cast in favour of growth. Monetarism would say that policies could only work on growth in the short run and inflation-targeting would be the right way to go. But if you were on the path of rational expectations, then what would matter is the surprise element. Otherwise we always say that the market has already buffered in the move which, in turn, means that it would not work. The present regime at RBI has had some surprises in the past.

RBI, quite rightly, never committed to any theory and kept options open, which is what it should be. But now, with the Urjit Patel Committee indicating inflation-targeting, with CPI inflation being the anchor, the market has assumed that lower inflation is a necessary condition for any rate action from RBI. The central bank evidently will not just go by the CPI number, though it would certainly play an important role on the chessboard.

What then are the possibilities this time Both growth in credit and deposits are subdued. RBI data shows that between April and July 11, incremental deposits are higher than the sum of credit and investments, which means that liquidity is not quite an issue today. Growth in deposits at 3.8%, though lower than 4.6% last year, has covered demand from the government and private sector. Logically, there is no reason to lower CRR or even SLR. The SLR stands at 26.7%, higher than the mandated 22.5%. Thus, even a token cut in SLR will not really work, though it can only signal that the central bank is willing to ease up here. But even last time RBI lowered the SLR, which may not have mattered but had the market on the back-foot considering that the authority sounded cautious on inflation.

GSec yields took a different turn with the new benchmark being announced at 8.4% compared with the 8.65-8.7% range for the existing benchmark. The new benchmark should lower rates, though the primary direction will come from RBIs monetary policy announcement. CPI inflation came below the 8% mark in June, though inflationary expectations are still not positive for a rate cut.

The monsoon does appear to be recovering, which can improve the situation, though one cannot be sure of the final kharif crop that will determine the direction in movement of prices. While we have buffers in rice, the same is not available for pulses, oilseeds, coarse cereals and sugarcane, and hence the element of uncertainty remains. In this situation, it appears unlikely that rates will be cut, and whatever has to happen on interest rates will be driven by the GSec market. The new benchmark will take time to evolve as there needs to be more than the present level of R7,000 crore to make it truly representative of the market conditions. The 8.83% security has stock of over R80,000 crore.

The monetary policy statement is anyway a short statement and the contours are fixed. There would be a call taken on expected growth in deposits and credit this year and any revision in the macro targets of GDP and inflation. The GDP growth range of 5-6% with mean of 5.5% is similar to what the ministry of finance has assumed in the Economic Survey and is unlikely to change as there are not really any fresh data points that have come in to justify any change in stance.

The view on inflation will be cautious and while the Iraq crisis has moved over, there is still some concern on the Israel-Palestine conflict. But the overwhelming factor will be the domestic developments relating to monsoon. Inflation in manufactured goods has shown upward tendencies though not serious enough to press the button. Therefore, all indications are that there should be an unchanged stance bordering more on caution and a wait-and-watch approach.

The next review would definitely be at a time when the clouds would clear on the domestic economic developments to gauge the future movements and hence a call on rates. Until then, industry will have to carry on with the status quo.

The author is chief economist, CARE Ratings. Views are personal