The Reserve Bank of India (RBI) reduced the Repo rate by 25 bps to 7.25%. This was the third consecutive 25 bps rate cut in 2013 and takes the total rate cuts since April 2013 to 125 bps. When seen from the overall easing cycle which began in October 2011, the CRR (Cash Reserve Ratio) has been reduced by 200 bps till date and the RBI has also added INR 2.8 trillion (1.5 trillion in FY 13 ) through Open Market Operations (OMOs). These are significant easing measures undertaken by the RBI to support the economy, industry and the banks. And they have down it to support the falling growth in the backdrop of a very high financial and macro-economic risks that surfaced during the period. I believe the RBI deserves more credit than accorded. Their talk has been hawkish but the actions have been what have been needed in the larger economic context. They have also adequately cautioned the market on the “limited space” available to ensure that the expectations do not run ahead of fundamentals.
They have utilized the small and intermediate opportunities available to be able to reduce rates and infuse liquidity and have shifted the focus on managing growth over inflation. One would rightly assume that this has been extremely difficult to communicate given that Consumer Price Inflation (CPI) has remained at elevated levels. They have cut CRR and reduced the repo rate since October 2012, as the WPI inflation peaked around the 8% mark and has now softened below 6% since. The 25 bps cut today is an extension of the same logic as they have seen the WPI inflation trend benign enough to be able to ease rates further.
I believe that with this 25 bps rate cut, the RBI has come very close to its rate cutting cycle. Although, I expect WPI inflation to fall in the coming months and also expect CPI to trend below the 8% mark, the RBI would ideally lower its inflation tolerance. The statement said that the Reserve Bank will endeavour to condition the evolution of inflation to a level of 5.0 per cent by March 2014, using all instruments at its command. I expect another 25 bps cut either in June or in the August policy.
The focus should now shift from repo rates to lending and deposit rates. I believe that cutting the repo rate more would lead to cut in deposit rates. At a time, when deposit growth has been muted despite high rates, it would be inimical for the economy to see lower deposit rates. To improve the financial savings in the economy, deposit rates need to be attractive to improve the banks liquidity and asset liability situation. At the other end, despite the monetary easing banks have not cut lending rates. Thus the transmission of the monetary policy actions have been only felt in the bond market and has not transpired into the loan rates. In order to further facilitate growth, a reduction in lending rates is necessary and RBI should nudge the banks to lower its net interest margins and lower the lending rates on all segments. RBI could also look at reducing the CRR rate in its next policy and reduce the SLR in its mid – year review. This would help banks release liquidity, reduce rates and increase lending.
The RBI has also been wise enough to caution on the temporary and transitory impacts of commodity price falls. Although, the fall in gold and oil is a welcome relief but unless permanent it cannot drive monetary policy decisions. The RBI has also cautioned on the fact that the external debt risks have risen due to the funding required for the higher current account deficit and on a global financial crisis, India would have a macro-economic problem which needs to be guarded against. All these makes us believe that the scope for further rate cuts is limited despite the lower growth and falling inflation.
I expect short term rates to be range bound as RBI will pro-actively manage the liquidity situation through OMOs, CRR cuts and the potential release of government excess cash balances. Long term bond yields will trend lower as near term data points would be favorable and the markets would start pricing in further rate cuts by the RBI.
Data Source: Bloomberg, RBI
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