As the RBI goes into another monetary review on October 04th, there are some key things to be watched for. It will be the first policy presented by the new RBI governor, Dr. Urjit Patel. It will also be the first monetary policy that will be announced under the aegis of the Monetary Policy Committee (MPC). More importantly, the monetary policy will be announced at a time when the US will be doing 2 additional Fed meets this year as well as the crucial presidential vote in November. It is in this light that the forthcoming RBI policy on October 04th assumes importance.
Inflation scenario supports a rate cut…
For over 3 years since Dr. Raghuram Rajan took charge at the helm of the RBI, the singular focus has been inflation control. This is evident from the fact that the RBI and the government have been chasing a long term inflation target of 4% religiously. The fall in CPI inflation from 6.07% in July 2016 to 5.05% in August 2016 is not just a flash in the pan. In fact, the pattern is a repeat of the previous year when we saw inflation coming down in the second half due to the base effect. There are additional advantages this year. There has been a good monsoon (nearly 96% of the LTA) as well as a record Kharif output is expected. These will combine to keep CPI inflation in check till the end of the calendar year. Thus retail inflation creates a positive environment for a repo rate cut in October.
Industrial growth is weakening consistently…
IIP growth for the month of July was negative and manufacturing was the real contributor to weak output. Lower rates could be the key trigger for a pick-up in growth. Of course, one can argue that transmission is not happening. That is a logical argument as the RBI has admitted that transmission has been less than 50% to the end borrower. But that will change drastically as PSU banks get a better hang of the NPAs in their books. Measures like AQR and the SMA-2 provisioning requirements have helped to substantially clean up the balance sheets of banks. Of course, a $100 billion NPA mountain cannot be wished away but one can surely hope for better transmission of future rate cuts. This factor again favours a rate cut in October.
Do we need to worry about the rupee?
One of the major arguments against rate cut was that a rate cut will result in the INR weakening versus the dollar. More so, when the US Fed has been talking a hawkish tone and India has $22 billion of FCNR redemptions this year! The memories of 2013 are still fresh in the mind of the RBI when a weakening rupee led to a surge in outflows as over $12 billion flowed out of India’s debt markets. But then, this time it is different for 3 reasons. Firstly, a slight weakness in the INR will be welcome as the rupee is already overpriced in REER terms. At least, it will come to the rescue of exporters. Secondly, crude oil is well under $50/bbl and that has resulted in the CAD coming down to 0.1% of GDP as against 4.5% of GDP in 2013. Lastly, the fear of rising global volatility due to monetary divergence will ensure that the US will be cautious on hiking rates and try to back-end it to the extent possible. So, even in terms of the INR value, there does not seem to be any real concerns over a rate cut by the RBI.
Finally, it could be all about the MPC…
At the end of the day, what could actually tip the scales in favour of a rate cut in the October policy would be that the MPC will be taking a final call on the repo rates. Unlike in the past, when the RBI governor had the veto power and actually exercised it, in the new dispensation the RBI governor will only have the decisive casting vote in the event of a tie. Otherwise, it will be the MPC that will prevail. The good thing is that it will be instrumental in giving a greater institutional flavour to rate decisions. With equal representation from the RBI and the Ministry of Finance, the MPC is likely to be more inclined to balance the interests of monetary policy and industry.
So, what does it augur for rates on October 04th?
When the RBI announces the monetary policy on October 04th, it may actually give greater precedence to domestic drivers rather than to global concerns. The imperative at this point of time is to boost industry through lower rates. The government has already given a demand push through greater infrastructure investments, rural spending, 7CPC and OROP. The next step will be to address the supply-side concerns. A rate cut could be a beginning in the right direction. The RBI may end up cutting rates by 25 basis points in its October policy and leave headroom for another 25 basis points cut by March 2017. That could be real booster dose that industry has been waiting for!
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