A token cut likely from RBI

There was a time when Finance Ministers and top ministry officials kept their expectations from the central bank, to themselves.

That was probably the result of an unwritten code that the central bank would consult the finance ministry about its options, subject to an informal understanding that the latter lot would keep their reservations to themselves and not engage publicly in any debates.

That era is now over.

Every one has joined the ‘expectations’ bandwagon. The Finance Minister has himself thrown explicit hints that he expects the Reserve Bank of India (RBI) to cut its key policy rates. “Monetary policy must move in step with fiscal policy”, he said on a couple of occasions recently.

Decoded in simple language, it means, do as I say.

That not-so-nuanced suggestion alone is probably the strongest reason to believe a cut may happen now, as the RBI readies for its second quarter monetary policy review on Tuesday.

There has been pressure on the RBI governor to cut rates for the last six months.

But after his ‘front- loaded’ 50 basis point repo rate cut in April, he has remained unmoved, even as the Indian economy has slowed down to a growth rate of around 5 per cent, from the heady 9 per cent levels of 2004-05 to 2010-11.

Inflation worries

For the RBI, the problem is that inflation remains above what it considers a comfort threshold. This, notwithstanding 13 hikes in policy rates prior to the April cut. And it is this concern over persistent inflation that has been the major determinant of RBI action over the past year or more.

The latest wholesale price index-based inflation numbers that came in earlier this month — at a 10-month high of 7.81 per cent — probably demolish the case for a reduction in rates now.

Moreover, the impact of the recent fuel price hikes is still to be fully passed through to the economy. That, too, doesn’t point to inflation numbers coming down immediately.

Yet, the atmospherics and sentiment that exist in the market today, not to speak of the not-so-subtle hints from the Finance Ministry, seem to be putting pressure on the RBI Governor to relent and cut rates.

If you recall, his April ‘cut’ was done in anticipation of reform measures, though markets have now conveniently forgotten that. At the same time, the flurry of reform announcements last month has created the illusion that the ball is now in the RBI’s court and it better not spoil the party.

Balancing act

The reform announcements are, no doubt, welcome to the extent of negating an impression of policy paralysis at the top. But many of these — in areas such as insurance or pension — are subject to necessary parliamentary approval.

True, stock markets have reacted positively to the Government’s reform measures, moving up 10 per cent in the past two months.

Confidence levels are also a shade better than before, and some foreign money does seem to be flowing in. The monsoon’s late recovery has also helped douse inflationary expectations in food articles.

But investment expenditure by companies is yet to begin. Even commodity prices, while they have weakened a tad in recent weeks, remain at elevated levels that are far from comfortable.

But there is also an argument that the revival of animal spirits can happen only if consumption spending recovers first. So to trigger more car, home and appliance purchases, a cut in policy rates will help reduce equated monthly instalments to make them more affordable.

At the same time, giving in to industry and bank demands for deep cuts now runs the risk of damaging the RBI’s inflation fighting credentials.

Given the balance of various factors, we may well see the Governor opting for a token cut of 25 basis points in the RBI’s repo/reverse repo rates and, perhaps, a similar cut in the cash reserve ratio requirements for banks.

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