Any interest rate cuts that we will see this year are likely to be short-lived because the Reserve Bank of India (RBI) will come under pressure to raise rates soon enough. That’s according to Michael Spencer, chief economist (Asia Pacific) for Deutsche Bank, who spoke to Mint in an exclusive interview.
Spencer predicts a 100 basis point rate cut between now and August. “I think 7.5 percent is the bottom before rates start rising again,” he said. The repo rate — the short-term rate at which commercial banks borrow from the RBI — currently stands at 8.5 percent.
The big bump-ups to inflation will occur primarily from rising fuel and food prices. Railway freight rates were hiked on Wednesday and oil marketing companies have been talking about hiking petrol prices by as much as Rs 5 per litre. Next up will be diesel prices.
“Diesel prices in the last seven years have risen 30 percent, but global prices for crude have more than doubled,” pointed out Spencer. “I am fairly confident that in the budget, or soon after the budget, we will get a decent fuel price increase — could be 10-20 percent,” he said. He added that for every 10 percent increase in fuel prices, inflation could rise by 1 percent over the next 12 months.
Food prices, after falling dramatically since December, are also poised to climb again as the high base effect of last year wears off.
That means the RBI is poised to cut rates just as inflation threatens to jump once again. While expectations are high that the central bank will cut rates in March/April to boost sagging economic growth, it’s likely the RBI will be inhibited from cutting rates too aggressively as it keeps in mind future inflationary pressures.
So after a hike of 350 basis points since March 2010, the best we can hope for is a 100 basis point cut (100 basis points = 1 percentage point) this year. Without aggressive rate cuts, economic recovery will not be swift or sharp.
A report in The Economic Times sums up perfectly what to expect in the new financial year: “Given the state that the economy and the policymakers are in right now, for the year ahead, we can expect a 7 percent growth, a reduction in rates by 100 basis points and an average of 7 percent inflation. Accept this as the new baseline.”