RBI’s Wait And Watch Policy May Signal End Of Rate Cut Cycle

The US Fed’s expectations of three rate hikes perhaps has influenced the status quo and the domestic economy is likely staring at the fag-end of the rate cut cycle. Markets, however, remain calm.

As was widely expected, a 25 basis rate cut did not come about as the Monetary Policy Committee decided to keep the status quo on rates. Domestic inflation has been stiff at current levels while the effects of demonitisation are still being felt in the rural areas. However, liquidity in the economy is high and rates are likely to remain range bound.

Says Kuntul Sur, Leader – Financial Risk and Regulatory, PwC: “The RBI has refrained from reducing the repo rate as the impact of demonetisation is not fully visible. Banks are anyway flushed with liquidity and in some sectors like home finance, we have already seen a reduction in interest rates. At this juncture, a further reduction in interest rate would not have given us the desired result.”

Experts point out that the US Fed’s expected three rate cuts could also have been weighing on the domestic policy front. A rate hike in the US will lower the gap between US and Indian interest rates, which could result in funds flowing out of the domestic market. Hence, there is a need for the status quo on domestic interest rates. But are we at the bottom of the interest rate reduction cycle just yet?

Sur believes that we are almost there. “Keeping in mind the international scenario, the US economy is expected to have three rate cuts, we expect we are looking at almost the bottom of the interest rate reduction cycle.”

The initial reaction in the stock markets were negative, but sentiments improved towards the end of the trading session. Says Motilal Oswal, chairman and MD, Motilal Oswal Financial Services: “Cut of 25 bps was widely expected and would have uplifted the sentiments. At this juncture, post long stint of shrinking economy and then demonitisation, people were postponing the demand. This rate cut was necessary from the perspective of bringing that demand back in the system.”

Stock markets have shown a flat close with the BSE Sensex ending about 45 points lower. However, experts believe that an earnings recovery is also likely to happen over the course of time and that if there’s a correction, investors could deploy additional funds into equities. Says Oswal: “From the long term perspective corporate earnings are showing some green shoots as against the weak expectation because of demonitisation. This correction should be used as an opportunity to deploy more money in the equity markets from the long term perspective.”