MUMBAI: Reserve Bank of India Governor Duvvuri Subbarao, who has resisted calls for an interest rate cut for months, may persist with his policy on Thursday as he awaits government finances forecast for the next fiscal, and get a handle on inflation, which is rearing its head again.
The governor, who looks beyond headline inflation numbers and is critical of the government’s finances, may not hurry to cut interest rates in response to slowing economic growth as his worst fear of inflation returning seems to be coming true, say economists.
More than two-thirds of the 16 economists polled by ET are voting for a pause by the governor in his mid-quarter policy review to be announced at 11 am today. Less than a third are betting on a rate cut since any delay may damage economic prospects. IndusInd Bank is alone in forecasting a 50 basis points cut, while the rest are for 25. A basis point is 0.01 percentage point.
If inflation does not come under control and the government does not provide a reliable guide to reducing fiscal deficit from an estimated 5.6% this fiscal, the policy rate cut may get delayed beyond April. Repo, the rate at which the RBI lends to banks, is at 8.5%; reverse repo, the interest it pays banks for deposits is a percentage point lower at 7.5%. The cash reserve ratio, the proportion of deposits to be kept with the RBI, after a 75 basis points cut last week is at 4.75%.
“We do not expect any rate cut,” said Taimur Baig, economist at Deutsche Bank. “We are now doubtful as to whether the central bank would be able to cut interest rates even in the April policy meeting.” Although the RBI desires to ease monetary conditions, “it will find it challenging to give a clear monetary easing signal for the time being”, said Baig.
Inflation, which showed signs of easing early this year due to the high base effect, is climbing again, dimming prospects of a rate cut. Crude oil, where India imports more than two-thirds of its needs, has risen about 17% this year. If the rise is passed on to consumers then prices of products will rise across the board. If the government subsidises, it ends up borrowing more from the market, pressuring interest rates.
The Wholesale Price Index rose more than expected at 7.0%, up from 6.6% in January. HSBC’s India manufacturing PMI was at 56.6 in February, indicating strong growth, though at a slower pace. Its service sector activity PMI was at 56.5. Any number above 50 indicates expansion. The unreliable Index of Industrial Production surprised with 6.8% growth in January, in contrast to a forecast of 2.1%.
“Based on the current inflation trajectory, including the fact there is considerable suppressed inflation, it is premature to begin reducing the policy rate,” Subbarao said on January 24 during the quarterly monetary policy review.
“The anticipated fiscal slippage, which is caused largely by high levels of consumption spending by the government, poses a significant threat to both inflation management, and more broadly, to macroeconomic stability.”
Nothing much has changed since then. Indeed, fundamentals have deteriorated with the economic growth forecast cut to 6.9% and the government’s tax revenue falling short of target and disinvestment of stakes in state-run companies floundering.
But it may be better to cut rates for the RBI now than holding on till April as factors such as oil price could hardly change and the fiscal scenario may not be dramatically different.
“Once it is clear that the current level of Repo rate may be restrictive in the context of slowing growth, we see little reason to wait till the April policy. We think that the commonly cited reasons for a delay – oil prices and Budget on March 16th – do not hold up to scrutiny,” A Prasanna, chief economist, ICICI Securities Primary Dealership.