The RBI should not wait; it must cut CRR and rates now

As inflation shows signs of easing, the Reserve Bank of India will have to have a very strong reason to tread cautiously on rate cuts. The economy is still slowing, and if the RBI does not act quickly the danger of a free fall is not ruled out.

Rate cuts work with a lag. Even if RBI starts cutting rates now, the effects will be seen only in the second half of fiscal 2012-13. The longer the RBI holds back rate cuts, the longer the time frame for an uptick in the economy.

Inflation printing at 7.5 percent levels (or thereabouts), GDP growth forecasts revised downwards to 7 percent (or below), tight liquidity conditions, weak credit growth, downbeat corporate sentiments, gloomy global economic forecasts and financial market volatility are the reasons why RBI should cut policy rates on CRR (cash reserve ratio) and repo by 50 bps (100 basis points make 1 percent) in its 24 January policy review.

 The RBI should not wait; it must cut CRR and rates now

The longer the Reserve Bank of Indiaholds back rate cuts, the longer the time frame for an uptick in the economy.AFP

If inflation comes in below 7.5 percent from 9.13 percent levels seen in November 2011, it will be at two-year lows. The fall in inflation for December 2011 is being led by a fall in primary articles inflation (with a 20 percent weight in the overall index). Primary articles inflation has come off from 6.9 percent in November 2011 to 0.51 percent in December 2011.

The fall in primary articles inflation is led by food inflation, which has come off from 6.6 percent levels to -2.9 percent levels. Inflation in all likelihood will breach the RBI's estimate of 7 percent for March 2012 on the downside as the drivers of inflation, including credit growth, liquidity and consumption demand, are clearly weakening.

Liquidity, as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI is staying above RBI's comfort levels of 1 percent of NDTL (net demand and time liabilities), which is around Rs 60,000 crore. Bids for repo in the LAF averaged Rs 128,000 crore on a daily basis last week, up from Rs 96,000 crore seen in the week before last. Liquidity is tightening despite RBI's infusion of Rs 53,000 crore through bond purchases. There are structural issues affecting liquidity and RBI will have to cut CRR to ease liquidity.

Bank credit growth has come off to 15.9 percent year on year as of end-December 2011. Credit growth is down from 22 percent levels seen in the beginning of fiscal 2011. Monetary tightening and tight liquidity conditions have impacted credit growth.

The RBI has raised repo rates by 175 bps this fiscal to bring down inflationary expectations. Sound bytes from bankers indicate that credit growth is unlikely to take off on the back of worries of non-performing loans.

Corporate sentiments are downbeat. Companies such as Bajaj Auto, which were seeing healthy double-digit growth in sales of two-wheelers until November 2011 despite rising interest rates are now sounding cautious on growth. The company is seeing weakness in rural demand, which is worrying given that rural demand is seen as one of the positive factors for the economy.

Infosys, the technology bellwether, has guided for no growth in the fourth quarter of 2011-12, citing high uncertainty in its main markets of the US and Europe.

Global economic turmoil is continuing, with the latest downgrades of credit ratings by S&P of eurozone countries, including France, Austria, Italy and Spain. S&P downgraded the sovereign credit ratings on 13 January, citing lack of progress in fiscal consolidating in the eurozone. Economic growth in the eurozone is likely to stay flat or even fall into minor recession on the back of austerity measures adopted by Eurozone countries.

The financial markets have had a very poor year in 2011. Equity indices across the globe fell in calendar 2011 on the back of debt issues in the eurozone and inflation issues in emerging markets. Currency markets are exhibiting high volatility with the Indian rupee falling by over 15 percent against the US dollar in the last one year. The euro has fallen by over 10 percent against the USD in the last four months and is likely to fall further post the downgrades. Financial market volatility is likely to continue into 2012 given the issues surrounding India and the world.

The government has sounded out a further revision in GDP growth from 7.5 percent to below 7 percent for fiscal 2011-12. GDP growth has been steadily revised downwards from levels of 9 percent forecast in the budget for 2011-12.

The IIP (Index of Industrial Production) growth for the April-November 2011 period, at 3.8 percent, is down from 8.4 percent growth levels seen in 2010-12. Falling credit growth, downbeat corporate sentiments and global economic turmoil all suggest GDP growth slowing down faster than expected.

Arjun Parthasarathy is the Editor of, a web site for investors.

Updated Date: Dec 20, 2014 08:02:14 IST