RBI cuts rates, banks follow, will consumers spend?
The central bank didn’t disappoint and delivered the expected 25 bps rate-cut, but far from boosting market sentiment, it gave them a serious fright and markets ended the day 661 points lower and bond yields 8 bps higher—it is difficult though, to separate the impact of RBI’s guidance and the Met’s forecast that projected a 12% deficient monsoon. Though the CSO painted a rosy picture for FY15, RBI Governor Raghuram Rajan talked of the poor growth impulse in the economy and said “a more appropriate stance is to front-load a rate-cut today and then wait for data that clarify uncertainty”. In other words, unless inflation remains under control—RBI has raised its inflation forecast a bit for the year—there are unlikely to be any more rate cuts. RBI’s projected inflation for March is around 6%, so with a 1.5-2% real rate that Rajan has said he wishes to maintain, there is little scope for further repo cuts.While banks have so far cut rates by 30 bps as compared to RBI’s cuts of 75 bps since January, further cuts will depend upon whether the costs of funds for banks come down—though banks have cut deposit rates by nearly 100 bps over the year, the actual cost of funds will depend on how fast the older deposits transit to the lower rates. As SBI chairman Arundhati Bhattacharya pointed out, the fact that small savings rates are high also puts a floor to how much banks can cut fixed deposit rates by.
How the economy will respond to the cuts, and the possibility of a poor monsoon is not too clear—private forecaster Skymet is sticking to its above-normal prediction arguing this year could be like 1997, an El-Nino one but a normal monsoon year due to the Indian Ocean Dipole effect. With India Inc unlikely to invest soon due to its large indebtedness as well as lots of spare capacity—nearly 40% in the auto sector and 30% in cement—what matters is public investment as well as private expenditure, given how government spending is constrained by the fiscal deficit. To the extent Crisil was, before it cut its forecast, looking at private consumption growth of 7% in FY16 versus 6.3% in FY15, rate cuts will be helpful, but unless consumers see jobs growth picking up, consumption may be affected—the fact that construction growth fell from 7.6% in H1FY15 to 2.3% in H2FY15 suggests jobs creation could remain poor since this is a very labour-intensive sector. A lot then depends upon how public investment—particularly in roads and railways—fares, since this is the area where the most money is being pumped in as well as promised. If the monsoon is like it was last year, a clear 50-60 bps can be shaved off whatever growth forecasts have been made since not only will agriculture growth collapse—it was 0.2% in FY15 after 3.7% in FY14—this will hit the already poor levels of rural demand.