The week ahead is likely to see the third interest rate reduction since January with the market expecting 25-basis points (bps) cut by the Reserve Bank of India.

The central bank will announce its second bi-monthly monetary policy review in 2015-16 on Tuesday.

In the current economic scenario, a repo rate (the rate at which banks borrow from the RBI) cut and government spending are likely to revive corporate investments in the infrastructure space and is likely to trigger credit pick-up.

It is further expected to come as a booster for capital-intensive sectors that have been deferring investments due to high costs and low capacity utilisation.

Though bankers have demanded a 50 bps cut in Cash Reserve Ratio (CRR – bank deposits parked with RBI without interest) as well, the RBI is unlikely to oblige due to the weak credit offtake and adequate liquidity in the system.

Since the beginning of this year, the central bank has reduced the repo rate by 50 bps (two rate cuts of 25 bps each).

Scope for accommodation

Keeping the repo rate unchanged at 7.5 per cent in its first bi-monthly policy review of 2015-16 on April 7, RBI Governor Raghuram Rajan had said that going forward, the accommodative stance of monetary policy will be maintained, but monetary policy actions will be conditioned by incoming data.

“First, the Reserve Bank will await the transmission by banks of its front-loaded rate reductions in January and February into their lending rates,” Rajan had said.

After he nudged banks to pass on the existing rate cuts, many banks have been reducing their base rate or the minimum lending rate by about 10-15 bps.

However, the transmission has not taken place in entirety as bankers feel that a rate cut may not trigger credit demand. However, data released earlier this month showed that the April Consumer Price Index (CPI)-based inflation eased to 4.86 per cent, the lowest in four months, owing to declining food prices. Inflation has been undershooting RBI’s latest inflation trajectory and this has led to hope of another rate cut.

RBI’s inflation target has been set at less than six per cent by January 2016 and four per cent (+/-2) by the end of the two years starting 2016-17.

As per a report by Deutsche Bank, while public investment may be the most critical driver for economic revival, until private sector recovers, one of the important triggers for growth revival will be a cut in interest rates. “Triggers that could bring markets out of the current stupor are — a 50 bps rate cut by RBI in the next monetary policy meeting due on June 2 and the passage of the Constitutional Amendment Bill for goods and services tax in the Monsoon session of Parliament,” the report said.

State Bank of India is of the view that “a 25 basis point cut in repo rate on June 2 now looks a certainty, and it may be a surprise if it does not happen.”

Echoing a similar view, former Chairperson and Managing Director (term ended on May 31) Bank of India Vijayalakshmi Iyer also expects a 25 bps cut on Tuesday.

On the other hand, some feel the RBI may wait for further transmission of the previous rate cuts by banks.

Arun Singh, Senior Economist, Dun & Bradstreet India, said, “It might be prudent to hold the policy rate steady for the time being as upside risks to food inflation still persist. As rightly indicated by the RBI, the extent of the transmission of the previous policy rate cuts should be factored in before initiating further policy rate easing.”

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