MUMBAI: While slowing growth, lower core inflation and fall in crude oil prices make a case for rate cuts in the upcoming policy review, economists say the central bank will have to be cautious. The Reserve Bank of India (RBI) is set to announce the mid-quarter policy review on June 18.
“There would be pressure on RBI to cut interest rates because growth data has been weak but the real question is whether the cost of capital will actually come down,” said Chetan Ahya, Asia-Pacific Economist, Morgan Stanley.
On April 17, the central bank began a monetary policy reversal cycle after raising rates between March 2010 and October 2011. “You can see commercial paper rates and inter-bank deposit rates. These have remained at an elevated level even when RBI has cut policy rates by 50 bps (basis points),” said Ahya. He doesn’t see the cost of capital coming down until credit growth decelerates further.
As on May 18, annual credit growth was 17.4 per cent, while deposit growth was at 13.8 per cent. “So, we may temporarily bring down the cost of capital effectively with a monetary policy response but it will not be sustainable if it is going to increase the imbalance in the system, of credit growth growing faster than deposit growth,” said Ahya.
In January-March 2012,India’s gross domestic product (GDP) growth fell to a nine-year low of 5.3 per cent. “While the weaker-than-expected GDP number has added pressure on RBI to cut rates, the sequential GDP growth rate and PMI (purchasing managers index) numbers suggest growth momentum may not be that weak and that inflation pressures remain firm,” said Leif Eskesen, chief economist for India and Asean (Association of Southeast Asian Nations) at HSBC.
HSBC says services sector activity inIndiagrew at a faster pace in May, with a PMI of 54.7 against 52.8 in April. Eskesen said any further easing in monetary policy could not, therefore, be aggressive and had to be approached with caution.
Economists at Nomura expect a policy rate cut of 25 bps instead of an aggressive 50 bps next fortnight, due to headline inflation that has not yet shown a continuous downtrend, with persistently high food inflation.
While core or manufactured products, inflation stabilised at five per cent in the first month of the current financial year, food inflation crossed the double-digit mark. This led headline inflation back to above seven per cent.
“When inflationary expectations are in double digits and potential growth is at risk of falling below seven per cent, it will not take much for inflationary pressure to rear its head. Without concomitant fiscal tightening, loose monetary policy will likely fan inflation and lead to greater macroeconomic instability down the road,” said Sonal Varma and Aman Mohunta, economists at Nomura.
RBI Deputy Governor Subir Gokarn recently said the central bank could draw comfort from easing crude oil prices and moderation in core inflation. This, coupled with lower-than-expected GDP data, has fuelled hopes of an aggressive rate cut on June 18.
Yields on the 10-year benchmark government bond have fallen from 8.5 per cent to 8.3 per cent levels within a week, reflecting market sentiments.
Brent crude oil prices fell to $98 per barrel from $110 per barrel in a span of two weeks. “Notwithstanding the rupee depreciation over this period, the drop in oil prices has gone a bit above the extent of rupee depreciation. So, there is some elbow room there,” Gokarn had said.