Prayers for rate cut may be answered in Jan, but 2012 will be a tightrope walk

After 13 rate hikes and a pause in its last policy review on 16 December, the general view taking hold is that the Reserve Bank of India (RBI) will likely begin cutting rates even before April 2012, given the dovish tone of its latest review. But 2012 will be be a major tightrope walk for policymakers and the RBI if a growth rate of around 7 percent is to be maintained.

Contrary to earlier expectations, analysts are now betting that an easing of the monetary cycle may actually begin earlier in the January-March 2012 quarter, and not after April 2012.

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Citi, for instance, has predicted that the RBI will have to begin the easing cycle around the first quarter of FY13 (2012-13). “The deceleration in growth coupled with a moderation in sequential inflation will likely result in the RBI easing by 100 bps in 2012 versus 50 bps expected earlier. (Note: 100 basis points make 1 percent). Growth slippages also raise the odds of an advancement of the easing cycle to 4Q FY12 (January -March 2012) vs 1QFY13 (April-June 2013),” says Citi economist Rohini Malkani in a report, referring to the RBI’s statement that the downside risks to the central bank’s own growth projections had increased significantly.

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“The RBI has raised rates 13 times so far, with effective policy tightening at 525 bps (with the repo rate currently at 8.5 percent). During this time, while WPI has remained elevated at 9 percent plus, GDP growth has come off from 9 percent to (around) 7% percent,” notes Citi.

Goldman Sachs, on the other hand, has said that the first repo rate cut will, in fact, be effected when RBI takes stock of its policy on 24 January. “Given the dovish tone adopted by the RBI and the rapidly deteriorating growth environment, we bring forward our forecast of the first repo rate cut to 24 January from March. Our December inflation forecast is currently 7.8 percent, materially below the 9.1 percent in November, while our FY12 GDP growth forecast of 6.9 percent (well below the RBI’s current forecast of 7.6 percent) has downside risks, says the Goldman report.

“With the focus on growth slowdown that the RBI has adopted, we think there is little reason for the central bank to wait till March before a rate cut. We are forecasting an above consensus 150 bps of rate cuts in 2012,” says Goldman’s Tushar Poddar.

Indranil Pan of Kotak Mahindra Bank says: “We believe that estimated GDP growth for FY2012 could be lower than 7 percent and could lead the RBI to start cutting the repo rate at its annual policy statement for FY2013.”

Be that as it may, by all accounts economists and analysts reckon the coming year will be tough despite the attempts at monetary easing.

A slowing economy will make life tougher, says Malkani in her analysis. There’s limited manoeuvrability on the domestic macroeconomic front. Pointing to the limited ammunition (in comparison to 2008) that Indian policy makers now have in the event of a crisis, the Citi report says this is on both the fiscal and monetary fronts, where higher deficits and stickier inflation would limit the space for conventional policy responses.

On the monetary front, persistently high inflation reduces the likelihood of rate cuts coming as rapidly as they did during the previous crisis. Pointing to the fiscal side, it says : “During the previous crisis, the deficit had consolidated to 4.1 percent of GDP in FY08. This gave the government enough fiscal space to take stimulus measures.”

But this time is different.

Twelve tasks for 2012

Rohini Malkani of Citi says in her report that 2012 will need to see 12 tasks undertaken to keep growth even around 7 percent:

1. Incentivising investments - Resolving power, mining, land issues

2. Foreign capital - Measures to attract flows

3. Inflation - Addressing structural issues

4. Fiscal - Some efforts towards consolidation

5. Politics - Current model of governance needs a revamp

6. Battling corruption and electoral reform

7. Improving data quality and dissemination

8. Labour reforms - Key to avoiding a demographic nightmare

9. Employment - The National Manufacturing Policy could help

10. NREGA - More productive work; putting funding to better use

11. Urban infrastructure - Key for balanced growth

12. Vigil on non-performing loans (NPLs) - To prevent negative feedback loop