While the RBI played ball with broader market expectation of a 25 bps reduction in the repo rate, it aptly, left the Cash Reserve Ratio (CRR) unchanged at 4.0%.
Post policy, the market disappointment was largely on account of no action taken on the liquidity front. We believe that current acute liquidity crunch is a manifestation of advance tax outflows coupled with tight fisted government maintaining a strong vigil on its spending in the current fiscal year. The transient crunch in liquidity is expected to be bridged by year-end residual government spending from the third week of this month, thus undermining the need for an immediate CRR cut. We can save that for later!
The rationale for the rate cut can be found in RBI placing greater priority on supporting growth than restraining inflationary pressures in the economy. Indias GDP growth in Q3FY13 softened to a 15 quarter low of 4.5%year-on-year, led by a slowdown in heavy-weight services sector.
On the growth-inflation dynamics, greater comfort came from a sharp slide in core inflation which posted a 35 month low at 3.76%, with the sequential momentum on a seasonally adjusted basis becoming negative for the first time in 45 months. Thus, despite rise in headline WPI inflation in February to 6.84%y-o-y from 6.62% in January, there were few alarm bells as this was solely driven by revisions of administered fuel prices coming on board. The continued moderation in core inflation validates the soft growth momentum in the economy and diminished pricing power in the hands of the manufacturers. In addition, a rate cut decision is likely to have been firmed by the governments displayed commitment towards fiscal consolidation in FY13 and FY14. The government successfully restrained its fiscal deficit for FY13 to 5.2% of GDP, and has pegged FY14 fiscal deficit target at 4.8% of GDP, in line with its roadmap for fiscal consolidation.
The more important question is: What next The RBI has clearly reiterated once again that sustained growth can come through reviving investments, which in turn, is largely a function of governments action in addressing supply constraints, adhering to fiscal consolidation and improving governance. Interest rates have a role to play, but at this juncture that of a complementary nature. In so far as future repo rate cuts are concerned, twin concerns of sticky elevated consumer inflation and wide current account gap will restrain RBIs moves. Meanwhile to enable effective transmission of interest rate signal, efforts should be channelised towards maintaining comfortable liquidity. We expect the RBI to announce Open Market Operations (OMO), the last auction in the current fiscal year likely this week itself.
The reason for the RBIs cautious guidance stems from concerns about governments ability to deliver on its promises for restoring sound macroeconomic environment, especially as the compulsions of political cycles mount in the run up to the 2014 elections. The recent track record of the government however, on delivering on promises gives us greater comfort and hope, notwithstanding the likely ramifications of the latest political developments. Against this backdrop we believe the RBI may continue to find some headroom to address growth risks. As such, we expect further reduction repo rate by 25-50 bps in CY 13 combined with a cut in CRR of 50 bps.
The author is chief eonomist at YES Bank, Mumbai