'A Rate Cut May Well Be Around The Festive Season'

On the face of Mint Road inflationary concerns seem to have held back Mint Road from slashing policy rates, but on a closer reading, there will be reason to cheer around the festive season.

On Tuesday, Reserve Bank of India’s (RBI) governor, Raghuram Rajan as expected kept the repo rate unchanged at 6.5 per cent; so too the cash reserve ratio at four per cent. That’s because retail inflation (Consumer Price Index; CPI) nosed up to a 22-month high level of 5.77 per cent in June (it was at 5.40 per cent in June 2015) on the back of an increase in prices of vegetables and cereals. CPI was marginally lower at 5.76 per cent in April. Now given the four per cent inflation target (for the next five years), the headroom for an accommodative monetary policy has largely dried up.

Read between the lines

But look beyond the move to hold key rates -- there are cues that appear to indicate a rate cut is on the cards.

Says Arubdhati Bhattacharya, chairperson-State Bank of India: “The RBI decision to maintain status-quo was as per market expectations. The decision to frontload liquidity provisions through an announcement of OMO is a well thought out move as capital flows have been relatively slow this year given the global uncertainties, resulting in lower net foreign exchange acquisition. We believe transmission of rates will happen gradually over the next few months as credit growth picks up pace”.

It’s a view seconded by Rana Kapoor, MD & CEO, YES Bank: “In the coming months, the disinflationary impact will be upheld by a favourable monsoon and structural policy reforms instituted by the government. Hence, notwithstanding the current pause, this will engender 50-100 bps space for incremental monetary easing before end of fiscal’17”.

The focus seem to be on making sure that liquidity conditions remain adequate despite there being no rate cuts as evidenced from RBI’s frontloading of OMO – the purchase of securities by the RBI to inject liquidity in the system. It makes sense as given the lacklustre demand for credit, no point would have been served by cutting policy rates at this stage now; more visibility in needed on inflation anyway. Second, rate cuts in the past have not led to lending rate cut by banks. So it makes sense to wait.

Rajan’s touched upon the structural issues regarding the transmission effect of lending rates – they still hold firm despite cuts in policy rates over the year. He alluded to the fact that bankers seem to come up with fresh excuses for not passing on policy rate cuts to customers: “Earlier, some bankers said that it was the lack of liquidity that was holding rates high, now I hear from some that it is fear of the FCNR (B) redemptions that is making them reluctant to cut rates. I have a suspicion that some new concern will crop up once these redemptions are behind us”.

In effect, Rajan seems to concede lending rates should be lower than what they are now – just that banks have not passed on past policy rate cuts. As for a fresh policy rate cut, Rajan may have left it to the new person on the 18th floor at Mint Road to take a call.