One of the highlights of the previous week was the CII representation to the RBI governor, Shaktikanta Das. The representative body of Indian industry has called on the RBI to aggressively cut the repo rates by 50 bps and also the Cash reserve ratio (CRR) by 50 bps. According to the CII, such a move would have the dual effect of making funds cheaper in India and also ensure abundant liquidity in the market. Why this request and is it feasible?
Inflation and growth
Broadly, there were three reasons for the CII request to the RBI governor. Firstly CPI inflation for the month of December touched an 18-month low of 2.19% even as the WPI inflation fell closer to 4.4%. Low inflation is normally the biggest trigger for a cut in repo rates. Secondly, the RBI had hiked the repo rates in 2 tranches of 25 bps each in June and October. This move to cut the repo rates would, at least, bring down the cost of funds and keep the real interest rates at reasonable level. There is also an IIP angle to this. The Index of industrial production (IIP) was principally reflective of weak growth in the economy overall since IIP is the largest component of GDP growth. Thirdly, CII also wants to ensure that apart from cost of funding, the problem of value depreciation on bond holdings of banks, NBFCs and mutual funds is also under control. CRR will provide the much needed liquidity.
Why CRR cut is unlikely?
The cash reserve ratio (CRR) reflects the deposits that the commercial banks maintain with the RBI. These are non-remunerative assets for the banks and more for statutory requirements of safety and integrity of the banking system. The government is already aggressively spending ahead of the elections. In fact, the farm package alone is expected to be close to $35 billion. In addition, China has already announced an $85 billion package to prop up growth and that is also likely to spur liquidity across world markets. A sharp CRR cut will lead to a spurt of liquidity in the banking system. The RBI would be wary of triggering higher inflation through such sudden liquidity infusion measures.
Calibrated rate cuts
The RBI may probably look to shift to a neutral to dovish stance in the February policy and probably consider a rate cut in the subsequent policy. The RBI would still be very cautious about a 50% rate cut as it would not only stoke inflation but also lead to a weakening of the Indian rupee. That is something that the RBI would want to avoid, looking at its stagnating forex reserve chest. RBI would also be hard pressed to ensuring that rate cuts do not take advantage of the spread that Indian bonds are enjoying today. That will make the RBI a lot more cautious on rate cuts! ©