Will RBI cut the repo rate sharply in the upcoming policy?

Radhika Merwin | | Updated on: Dec 06, 2021

While the domestic slowdown and benign inflation have raised expectations of a steep cut by the RBI, the escalating US-China trade war and weakening of the rupee could temper the central bank’s action tomorrow

Rising concerns on a growth slowdown in the domestic market and a favourable inflation trend have raised market expectations of a sharp cut in repo rate by the RBI, in the past month. After cutting its policy rate by 25 basis points and changing its stance from neutral to accommodative — in the June policy — the RBI threw open the possibility of more rate cuts in the coming months. June CPI inflation remaining well below the RBI’s 4 per cent target (though food inflation inched up) has also kept expectations of a rate cut in the August policy, intact.

While a rate cut could well be on the cards in Wednesday’s policy review, the million dollar question is: how much will the RBI deliver by way of a rate cut this time around.

Over the past few weeks, fresh concerns on domestic growth and a rising wave of monetary easing all over the world, have increased expectations of a sharp 35 or 50 basis points cut in repo rate by the RBI in the August policy. But with US President Donald Trump imposing new tariffs on Chinese goods last week and the escalating trade war between the two countries, turbulence in financial and currency markets globally may force the RBI to take a less aggressive stance on its rate action.

The rupee, which was holding well, has come under sudden pressure. A sharp cut by the RBI could only do more harm than good at this juncture.

Growth and inflation dynamics

Rate action by the RBI has always hinged on the growth-inflation dynamics at play.

On the growth front, the persisting slowdown in demand reflected in the recent auto sales numbers and weak consumption, further accentuated by the ongoing crisis in the NBFC sector, have only strengthened the case for a further monetary easing.

GDP growth fell sharply in the March quarter of FY19 to 5.8 per cent (in real terms), led by a slowdown across agriculture (negative growth), manufacturing, construction and trade. With consumption remaining weak, and sluggishness in private investment activity, GDP growth could well dip lower in FY20, from the 6.8 per cent level in FY19.

The inflation trend so far has also been benign. In June, while CPI inflation moved up to 3.18 per cent from 3 per cent in May — on the back of higher food inflation — core inflation (excluding food and fuel) has been inching lower. Inflation in clothing, housing, health, transport and education has been trending lower over the past few months, accentuating growth concerns.

While food prices on a low base may inch up in the coming months, a fall in crude and commodity prices could keep overall inflation under check.

Hence, with a favourable underlying growth-inflation mix, there is a high possibility for the RBI to deliver more rate cuts in the coming year.

How much?

Until last week, the possibility of a steep rate cut (over 25 bps) remained high, if domestic factors alone were considered. But two events in the past week have weakened the probability of a sharp rate cut.

One, the Fed delivered on expected lines and cut the rate by 25 basis points. But the Fed Chairman Jerome Powell's remarks that the central bank was not intending to embark on a long cycle of rate easing, have now dampened hopes of further cuts. This could well tone down rate actions by the RBI.

This is because while the RBI still has leeway to lower interest rates sharply, going strictly by the rate differential between the developed and emerging economies, a weak rupee may play truant.

Foreign investors have been net buyers in Indian debt so far in the current fiscal, thanks to high interest rates. But the flows have also been aided by a strong rupee. Trump’s action last week has sent rupee into a tailspin and upset the apple cart. If the RBI does a sharp rate cut at this juncture, it could very well put the one thing that has been playing in its favour -- increasing flows into the Indian debt market.

Weak transmission

Also while the noise around sharp cuts in the industry have become louder, it is well known that the RBI wielding the scissors alone and cutting rates will not bring down borrowing costs for India Inc.

The RBI has cut the repo rate by 75 bps so far this year, but lending rates have only moved lower by 10-15 bps. SBI, only recently, cut its deposit rates sharply -- how much of this will translate into lower lending rates needs to be seen.

Published on August 06, 2019
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