RBI Cuts Repo Rate by 25 bps

Posted On Wednesday, Aug 02, 2017

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As was widely expected, the RBI cut the Repo rate by 25 bps to 6%. The 5-1 voting in favor of a rate cut also suggests that the decision was almost unanimous.

They have, wisely though, chosen to remain ‘Neutral’ on the future course of monetary policy stance.

This suggests to us that the bar for the next rate cut, if at all, is set higher.

We may have seen the last rate cut in this cycle and the RBI is likely to remain on hold at 6% for some months to come. The trend down in inflation in the last 4 months did indeed create some room and the RBI has seized that chance. That the fall in inflation was broad-based with prices of even services moderating allowed the RBI greater comfort to cut the Repo rate. But it was only a 25 bps cut. With the RBI itself now projecting the CPI to rise above the 4% (its target) mark in Q1 2018, it does not seem extremely confident of reducing rates further.

This should be disappointing to many who believed that based on the current inflation and growth trends, the RBI could have done more to support the growth revival. We believe that the current drop in inflation is to a large extent a result of the after-shocks of demonetization, which should reverse in the months to come.

Food prices fell post demonetization and are increasing only now as demand-supply balance is restored with improved market functioning. Similarly, a drop in demand due to the unavailability of cash seems to have also impacted prices of general goods and services.

The RBI has maintained its growth projections which suggests they expect demand to revive as the year progresses. They also indicated to the non-disruptive roll out of GST as a means of comfort to their GDP projection. The favorable monsoon and the good Kharif sowing of key crops does suggest that food production and resulting farm incomes should support the demand recovery. Food prices though need to rise from the current levels to help improve the incomes of the farmers and alleviate some farm stress. The recent rise in vegetable prices could be the first signs of it and needs to be watched closely.

The RBI also made a very strong reference to states a fiscal deficit and farm loan waivers which does indicate that they do not want to be complacent about oncoming risks to inflation and macro stability. The conditions appear balanced, but as we have noted in our earlier commentaries, it would be prudent for the RBI to remain cautious at this stage of the cycle.

We continue to maintain our view that the best of the bond market gains (in terms of capital gains) are behind us. Bond markets had completely priced in a 25 bps cut and hence we saw almost no change in the bond yields. Bond markets would remain range bound in the short term and await domestic and global trends to determine its future trajectory.

We expect deposit and lending rates to drop further in the coming months which will hurt the saver but benefit the borrower.



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Above article is authored by Quantum.

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