monetary policy review. Expect a 25 bps rate cut this Wednesday

The Centre’s commitment to fiscal consolidation and to borrow less in the next fiscal, coupled with the lower retail inflation data in December may give the Reserve Bank wiggle room enough to cut the policy rate by 25 basis points on Wednesday, in the last bi-monthly monetary policy review of the current fiscal.

The RBI had last cut the repo rate — the interest rate at which it lends to banks — by 25 basis points to 6.25 per cent in the October review.

The central bank held rates in the December policy review while retaining an accommodative policy stance. Overall, in the current financial year, the RBI twice cut the repo rate by 25 basis points.

With Finance Minister Arun Jaitley emphasising that the government had adhered to fiscal consolidation, market players feel this could support the disinflation process going forward, which, in turn, could create space for rate cuts.

Jaitley’s Budget pegged the fiscal deficit at 3.2 per cent of GDP for FY18 and the Centre is committed to bring it down to 3 per cent the following fiscal. The government’s net market borrowing in FY18 will be lower at ₹3.48 lakh crore after buyback, as against ₹4.25 lakh crore in FY17.

According to the Economic Survey, an economy recovering from demonetisation will need policy support. On the assumption that the equilibrium cash-GDP ratio will be lower than that prior to November 8, the banking system will benefit from a higher level of deposits, it said.

“Thus, market interest rates — deposits, lending, and yields on government securities — should be lower in 2017-18 than 2016-17. This will provide a boost to the economy (provided, of course, liquidity is no longer a binding constraint). A corollary is that policy rates can be lower, not necessarily to lead and nudge market rates, but to validate them. Of course, any sharp uptick in oil prices and those of agricultural products, would limit the scope for monetary easing.”

Pranjul Bhandari, Chief Economist, HSBC Securities and Capital Markets (India), feels that with oil prices on the climb, pressures from higher government wages, and Fed rates expected to rise, the space for rate cuts is quickly dwindling. But one final 25 basis points rate cut in the cycle is expected.

Retail inflation, one of the key gauges the central bank tracks in setting interest rates, eased to 3.41 per cent in December as against 3.63 per cent in November. This could cushion a rate cut in the post-demonetisation phase, say market experts.

In a report, Nomura said with the government sticking to fiscal consolidation and headline inflation likely to undershoot the RBI’s March 2017 target of 5 per cent, it is pencilling in a final 25 basis points repo rate cut to 6 per cent on February 8, although with global factors turning negative (higher oil prices, narrowing interest rate differentials), it would be a close call. Thereafter, Nomura expects both growth and inflation to accelerate, keeping the RBI on hold throughout 2017.

Kotak Securities analysis of revenue and expenditure indicates negligible fiscal impulse from the FY2018 budget. Hence, this strengthens its call for a 25 basis points rate cut in the next RBI policy.

A conservative fiscal policy, easing inflation trajectory and short-term risks to growth keep the door open for further easing, said Radhika Rao, Economist, Group Research, DBS Bank, adding it will, however, be a close call. As a base case, she expects a 25 basis points rate cut in the repo rate to 6 per cent on February 8.

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