Expectedly, India Inc, markets and analysts have given a thumbs up to the Reserve Bank of India for lowering its benchmark repo rate by 25 basis points in its January policy review, and cutting the cash reserve ratio (CRR) by another 25 bps. In fact, given the policy guidance from the central bank, analysts expect RBI to effect another 25 basis points cut in the repo rate, come March.
Says Tushar Poddar, managing director and chief India economist at Goldman Sachs: “In its forward guidance, the RBI stated that with headline inflation likely to have peaked, it ‘provides space, albeit limited, for monetary policy to give greater emphasis to growth risks’. This suggests to us, that the central bank is likely to ease further going forward. Barring an upside surprise on inflation in the near term, or the fiscal deficit during the budget, and given the explicit guidance, we now think that the RBI will likely ease the repo rate by 25 bps in its March 19 policy meeting. This is consistent with our earlier view of a cumulative 50 bps of repo cuts in Q1, and is also in line with current market expectations.”
However, despite the cheer after the RBI finally agreed to cut rates after nine months of holding firm, some sections of analysts and India Inc feel a sharper cut could have been in order, given that inflation had now eased. RBI, in its policy statement, has also lowered its FY13 inflation target to 6.8 percent from the earlier 7.5 percent. It, however, lowered the growth estimate too, from 5.8 percent earlier to 5.5 percent.
“RBI’s decision to ease the monetary policy through a repo rate and CRR cut is a welcome step as it sends out a positive signal that the central bank has now joined hands with the government to revive the growth momentum of the economy, which had to so far largely focused on containing inflation. Government’s continued thrust on reforms along with the downtrend in WPI-based inflation has provided necessary leg-room for RBI to maneuver its policy in favour of growth. However, CII would have been happier with a larger reduction in repo rate”, says Confederation of Indian Industry (CII) director general Chandrajit Banerjee.
“While the RBI action was ahead of market expectations, we were expecting them to ease more on repo rather than CRR. A front-loaded cut on the repo would have helped lower interest rates in the economy faster, in our view, and was justified by the downside surprises to inflation. The central bank, however, has taken the view that easing liquidity by cutting CRR will be of greater help in monetary transmission, and ease the growth process,” says Poddar.
Pointing out that RBI’s action was an acknowledgement of the government’s efforts on fiscal consolidation, HSBC chief economist for India Leif Eskesen says: “The RBI’s decision to cut was also a nod to the structural policy progress the government has delivered so far, although much more clearly needs to be done to re-invigorate investments and the supply side. The RBI also appears to have given the government the benefit of doubt, for now at least, when it comes to delivering fiscal consolidation.”
However, he says the statement was still relatively hawkish on inflation and the RBI signaled that further rate cuts are conditioned on inflation pressures easing as expected and Delhi continuing to deliver on other policy fronts. “Moreover, the RBI aptly remains concerned about the wide current account deficit, noting that this was also a constraint on monetary policy easing,” Eskesen adds.
On the structural policy front, he says: “We expect that the reform push will persist. But, reforms will inch rather than leap forward, especially on this side of the general elections. This will help gradually lift growth, but the recovery will necessity be protracted given the only gradual pace of reform implementation and time it takes for these reforms to have an impact on growth, beyond the near term impact they have on sentiments.”
Given this context, HSBC’s Eskesen says there is room for further rate cuts, but it is limited. “We are currently only penciling in another 25bp. Ongoing efforts to manage liquidity are also on the cards and needed to facilitate the transmission of policy rate cuts to lower lending rates. However, the timing and magnitude of any further easing will be determined, at least to a large degree, by the extent to which Delhi delivers,” he says.
In general, analysts are calling it a balanced attempt by RBI governor Duvvuri Subbarao. Says Indranil Pan, chief economist at Kotak Mahindra Bank: “In my opinion, RBI delivered a very balanced policy. As expected, they chose the calibrated path of a 25 bps cut in the repo and the reverse repo rates as they wanted to avoid a repeat of April 2012 when the RBI had cut the repo rate by 50 bps and then had to pause with surprises creeping in from the inflation side. On the other side, there is a clear acknowledgement from the RBI that demand side activity has remained low, growth has slowed below trend, probably needing the RBI to complement the reforms measures recently taken by the government.”
Pan feels that the room for further cuts could be limited. “RBI continues to tow the cautious line on inflation, CAD risks and indicates that the room to cut rates could be extremely limited. The problem for the RBI is also that it has started its rate cutting cycle at a time when most other economies of the world are finished with the cycle, were on a pause, and now are looking forward to again hike rates,” he points out.
Consequently, any aggressive rate cutting cycle, he says, could prove counterproductive as capital flows would be pared and the high current account deficit (CAD) could then manifest into a currency depreciation bias, which in itself would again lead to inflation pressures. “We now look for the RBI to reduce the repo rate by a further 50 bps in the rest of calendar year 2013,” he says.
RBI signaled that further rate cuts are conditioned on inflation pressures easing as expected and Delhi continuing to deliver on other policy fronts.