Policy tug-of-war in RBI over rate cut

Analysts and market watchers are split over whether the newly formed Monetary Policy Committee (MPC) will cut rates or maintain a wait-and-watch policy this week.

Softening inflation, slowing industrial output, likelihood of a US Fed rate hike, and the possible fallout of India’s surgical strikes on terrorist camps in Pakistan will be factored in when the Reserve Bank of India takes a decision in the upcoming policy review on Tuesday.

This will be the first policy review under the new RBI Governor Urjit Patel and it will be also the first meeting of the MPC.

The six-member Monetary Policy Committee will meet over two days – October 3 and 4 – in the run-up to the fourth bi-monthly monetary policy review to vote on the repo rate.

While the three MPC members from the RBI are likely to be on the same page, the other three government-appointed members may pull in different directions.

Madan Sabnavis, Chief Economist, CARE Ratings, said, “While under normal circumstances we would expect an unchanged (RBI) stance, depending on the seriousness of the battle and the reaction of the market, the RBI could consider more seriously a rate cut. The chances of such an action could increase until Tuesday depending on the course of the tension at the Line of Control.”

The latest macroeconomic numbers – consumer price index based inflation easing to 5.05 per cent in August from 6.07 per cent in July on the back of good monsoon rains; and the Index of Industrial Production dipping by 2.4 per cent in July against a growth of 1.95 in June 2016 – suggest that there is a case for a rate cut. However, the possibility of a US Fed rate hike (which could trigger investment outflows from emerging markets, including India) in December and RBI’s own assessment in its previous policy review that inflation (excluding food and fuel) may likely trend upwards, could see the rate being kept on hold.

Out of the three bi-monthly monetary policy reviews in this financial year so far, the RBI has cut the repo rate (the interest rate at which it provides liquidity to banks to overcome short-term mismatches) only once in April from 6.75 per cent to 6.50 per cent.

Soumya Kanti Ghosh, Chief Economic Adviser, State Bank of India, said, “We are still maintaining a 50 basis points rate cut in FY2017, though we believe the RBI may go more aggressive on liquidity for rate transmission…”

Though the rate cut may happen either in October or December, Ghosh believes the possibility of a rate hike by the Fed in December may prompt the RBI to cut rates in October.

HSBC, in a report, said, “There are some good reasons why a rate cut could materialise in the upcoming October 4 meeting. The recent fall in food prices has been sharper than expected, and cutting earlier keeps the RBI a safe distance away from possible Fed hikes.

“Yet, our base case is for a rate cut in December. This is because, by December, two new inflation prints which are expected to be well below 5 per cent will be available.”

Moreover, given that the RBI was highlighting upside risks until its last meeting, it may prefer to move in steps — change the outlook on inflation now and cut rates in December, the report said.

Furthermore, for greater monetary transmission, the RBI may want to get through the period of foreign currency non-resident (FCNR) deposit outflows before further cuts.

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