The last or the penultimate?

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Updated: Apr 04, 2016 1:19 AM

Based on the experience of 2015 when the Reserve Bank of India (RBI) had cut repo immediately after the Budget, the market was abuzz with hopes for a similar action by RBI this year, especially as the finance minister delivered on the 3.5% FD/GDP.

Based on the experience of 2015 when the Reserve Bank of India (RBI) had cut repo immediately after the Budget, the market was abuzz with hopes for a similar action by RBI this year, especially as the finance minister delivered on the 3.5% FD/GDP. However, RBI kept away from such a move, clearly an indication that the central bank was very close to the end of the easing cycle and does not think that it is behind the curve. This also meant that RBI was trying to be careful of not expending its firepower before it is due.

With RBI sitting it out till now, there is almost full consensus in the market that a cut of at least 25bps will be delivered on April 5. In September, RBI had reduced the repo rate by 50bps. Following that, the central bank maintained a status quo in the next couple of policies to judge the implications of an imminent US Federal Reserve rate increase and the fiscal policy direction. The 25bps cut is thus almost a given, as fiscal consolidation has been adhered to and there is now comfort from the global arena on risk perspectives. Further, while the US Fed rate increase in December turned out to be mostly a non-event, anticipations of significant tightening of interest rates in the US are also rapidly dying out as the commentary from the Fed is decidedly dovish. This definitely provides scope for emerging market economies, including India, to continue on accommodative monetary stance. Further, the last headline CPI reading at 5.2% was not only close to the coveted 5% mark but also surprised on the lower side.

While all the above open up a window for RBI to move with more easing, it could remain hesitant on delivering a large dose immediately. Importantly, the downshift of headline CPI inflation, as was experienced in the last couple of years, was based on a significant deflationary trend from the global arena on the back of sharp dips in commodity prices. Commodity prices seem to have now found a floor and it is extremely difficult to take any predictive call on this. And, any increase in oil prices could actually lead to the government passing the same off to the consumers, implying higher inflation.

Second, the view on monsoons is not crystal clear. The Southern Oscillation Index is better placed for a relatively better monsoon, but still remains in the El Nino zone. Critically, another year of poor monsoons in a situation where the reservoir levels are down to just 25% of full capacity can have severe ramification on agriculture as a whole—kharif and rabi taken together. Implications from the Pay Commission award on inflation still remain hazy as we await the decision on whether the implementation will be at one go or phased out.

But more important than repo rate reductions is the transmission of policy cuts to the real sector of the economy. Challenges do continue in this arena even as the new marginal cost of funds-based lending rate (MCLR) regime is showing around 15bps of further transmission of the past cuts. Expectations are that with the government having slashed interest rates on small savings scheme, the banking sector will be forced to bring down term deposit rates but this will take longer than probably being expected, given the liquidity tightness banks are faced with. Banks’ balance sheets continue to be stressed and it will take more time for the whole mess to wind down.

In the above context, there is some expectation in the market for RBI to categorically lay out strategies for liquidity management. While this may be important for monetary transmission, I think it would be difficult for RBI to argue for any liquidity solution that extends too much into the future. A portion of this liquidity deficit is frictional in the form of cash holdings by the government and is likely to come back into the system with the government spending kicking off in April. The riddle that remains unanswered is the high currency in circulation (CIC), but I would not expect RBI to supplement a higher CIC with liquidity infusions of permanent nature. While the 25bps cut being expected in April could be the last, the future direction will critically depend on evolving data—both domestic and global.

The author is chief economist, IDFC Bank. Views are personal

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