BW Communities

RBI Pleases, But Huge Rate Cuts May Have To Wait

Business World Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[It had started to hurt. And the Reserve Bank of India (RBI) felt it was time to do something drastic about it. The medicine -- a large 50 basis points (bps) cut in the repo rate to 8 per cent, much more than the anticipated 25 bps. Growth had slumped to 6.1 per cent in the third quarter of 2011-12 from 8.3 per cent in the corresponding quarter of the last fiscal. On the brighter side, headline wholesale price index (WPI) inflation, which had held firm at above 9 per cent during April-November 2011, had moderated to 6.9 per cent by end-March 2012, in line with the central's bank's projection of 7 per cent. It was a good time as any to cut the repo rate. "The rate cut is a substantial and meaningful measure. It should give banks the confidence to bring down wholesale deposit rates, which in turn would reflect in a reduction in lending rates. This would ease the interest costs of the corporate sector, as also give a boost to retail demand. The impetus that this would provide to the economy should see us achieve the projected pick-up in GDP growth towards the 7.3 per cent level indicated by RBI in its policy statement", says Chanda Kochhar, Managing Director & CEO at ICICI Bank. Can We Expect More Rate Cuts? The higher-than-expected rate cut resulted in the 10-year benchmark bond yield quoting 10 bps lower on the day at 8.35 per cent right after the policy announcement. But before you sniff further rate cuts, what is important to note is that inflation softened despite the rise in global crude oil prices. "It implies an absence of commensurate pass-through to domestic prices. Fuel prices are expected to remain elevated in the near future", notes out Madan Sabnavis, chief economist at CARE Ratings. The RBI makes a mention of this pressure point. "Going by the recent burden-sharing arrangements with the oil marketing companies (OMCs), the budget estimate of compensation for under-recoveries of OMCs at the present level of international crude prices is likely to fall significantly short of the required amount. Any slippage in the fiscal deficit will have implications for inflation". "A major factor affecting our growth and inflation prospects would be the exchange rate. The rupee has been volatile and the depreciation witnessed in 2011-12 has impacted the bottom lines of companies", points out Sabnavis. According to him, 25-30 per cent of our WPI could be influenced by exchange rate movement. "We expect upside risks on inflation to remain and therefore room available for further rate cuts is limited". Another factor that limits further rate cuts by RBI is the economy's trend rate of growth -- the rate that can be sustained over longer periods without engendering demand-side inflationary pressures. "Even though growth has fallen significantly in the past three quarters, our projections suggest that the economy will revert close to its post-crisis trend growth in 2012-13, which does not leave much room for monetary policy easing without aggravating inflation risks", says RBI. It goes to explain the main reason for the apparent decline in the trend rate of growth relative to the pre-crisis period -- the emergence of significant supply bottlenecks in infrastructure, energy, minerals and labour. Abheek Barua, Chief economist, HDFC Bank, has a different view on this issue. While the central bank has highlighted risk factors such as firm global commodity prices, possible hikes in administered prices of items such as fuel, power and coal and structural pressures from food prices, he feels there is a crucial difference between the central banks's reading of inflation now and its assessment of price pressures a month ago. "The central bank now seems more certain that pricing power of domestic producers has weakened considerably a fact that is of course reflected in the trajectory of core inflation", says Baruah. Core inflation has come off to below 5 per cent in end-March 2012, down from the high of 8.3 per cent in November 2011. Liquidity Will Be Under Strain The central bank has left the cash reserve ratio (CRR) -- the proportion of deposits required to be held in cash by banks with the RBI -- unchanged at 4.75 per cent. But the Marginal Standing Facility  which allows banks to  borrow overnight to the tune of two per cent of their net demand and time liabilities  (current, savings and fixed accounts) from the earlier 1 per cent. Liquidity has been tight since November 2011 with the borrowing approximately Rs 1,22,785 crore from the RBI's repo window. The RBI also upped its open market operations (OMO) -- it purchased Rs 1,42,500 crore of securities up to end-March 2012 compared with Rs 78,800 crore up to end-March 2011. This is over and above the cut in the CRR by 125 bps to 4.75 per cent. Let us look at the liquidity math now. The 17 per cent increase in bank non-food credit estimated by the RBI implies an increment of Rs 7.99 lakh crore in bank credit during 2012-13; the 16 per cent increase in bank deposits implies Rs 9.78 lakh crore increment in bank deposit during 2012-13. If you were to adjust the bank deposit for 4.75 per cent CRR and subtractg bank credit (food and non-food) from the same, banks would have surplus of Rs 1.16 lakh crore (Rs 9.32 lakh crore minus Rs 8.15 lakh crore) Further, net government borrowings stand at Rs 4.79 lakh crore, of which approximately Rs 1.92 lakh crore (40 per cent) would probably be held by banks based on RBI's data on present holding pattern of central government securities. Therefore, there could be a short fall of around Rs 80,000 crore, which would have to be supported by further OMO purchases by the RBI or another CRR cut, assuming the government meets its borrowing targets.