Finance Minister P. Chidambaram can look forward to some support from the Reserve Bank of India this time when it unveils its quarterly monetary policy review on Tuesday. There is a good possibility of at least a 25 basis point cut in repo rate, if only to boost sentiment in the economy.

The RBI has been steadfast in not succumbing to pressures from an assorted array of bureaucrats, ministers, economists, think-tanks and busybodies — for rate cuts right through the last year.

When it chose to ignore the flurry of government announcements in September and kept rates steady in its half yearly review in October, a rather disappointed finance minister, in an uncharacteristic display of petulance, said, “If the government has to walk alone to face the challenge of growth, we will walk alone.”

He added further that he hopes ‘everybody’ takes note of his statement that the government was determined to move forward on fiscal consolidation. No one had any doubts that the ‘everybody’ referred to in the statement was really the RBI governor.

Since then, the government has taken a couple of steps to convey its seriousness, including raising prices of diesel, hiking railway fares, increasing import duty on gold, and started a roll-out of direct cash transfers in a few districts, among many other steps.

Favourable signs

The RBI had provided some forward guidance in its October policy that it would look at cutting rates, provided the inflation trajectory showed signs of improvement.

For three successive months, there are signs that inflation numbers are inching down — albeit painfully slowly. WPI inflation reading for the month of December came in at 7.18 per cent, lower than 7.24 per cent in November and 7.45 per cent in October.

Although these numbers are still much higher than the indicated comfort level of the central bank, the signs are favourable. It is also true that there is every danger of inflation perking up a bit once more as soon as diesel, LPG and urea prices are hiked once more.

Yet, as the economy continues to slow down, there is a need to give it a fillip. The RBI itself has indicated that monetary policy must shift focus to growth, from inflation fighting, in its mid quarter review in December. That would translate into a rate cut which the governor can choose to do on January 29.

Muted expectations

Earlier, the market was betting on a 50 bps cut. But now, it is keeping its expectations muted and will probably settle for a 25 bps cut to spark sentiments. In any case, there is the possibility of keeping some further cuts in reserve to be delivered a month later to coincide with Budget moves.

Banks will be expected to cut rates immediately to deliver their part of the bargain and aid the revival of the investment cycle. The SBI chairman has indicated that his bank would be ready to cut rates as soon as the RBI cuts rates. For other banks, it will be a difficult call, since it will affect their margins.

If they, however, choose to cut deposit rates also, they run the risk of further alienating the depositor community already groaning under rates that are hurt by inflation. A difficult quarter or two ahead for banks.

(This article was published on January 27, 2013)
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