The Reserve Bank of India (RBI) is widely expected to lower interest rates by 25 basis points at its first bi-monthly monetary policy for the new financial year on Tuesday, April 5. RBI governor Raghuram Rajan has reiterated that monetary policy will be “data dependant” and this time a lot of the numbers seem to be adding up well.
Inflationary pressures have reduced and growth momentum slowed; the central government has also exhibited fiscal prudence by sticking to the 3.5 percent [of GDP] fiscal target for FY2016-17. All these give room to the governor to cut the repo rate. In February, Rajan had said that he would watch for the government’s Union Budget and inflation trends, before deciding on the next policy action.
Some economists say a higher-than-expected 50 bps rate cut might also be possible, after the government recently reduced interest rates on various small savings. Banks compete with several of these small savings schemes for deposits.
Banks will also watch for the RBI’s assessment of the liquidity situation as well as any changes to the existing framework. Volatility in the liquidity system has increased and some banks have asked the RBI to address existing norms relating to daily cash reserve ratio (CRR) balances of banks.
“We will look for his [Rajan’s] accommodative comments, relating to the policy. I will also keep a watchful eye on how the RBI would support liquidity needs in the system,” says Siddhartha Sanyal, chief India economist with Barclays Bank PLC. Sanyal expects the RBI to cut rates by 25 bps on Tuesday.
At present, banks have to maintain a cash balance of 95 percent of the required CRR (4 percent of the net demand and time liability of the bank) on a daily basis. Nomura analysts Sonal Varma and Neha Saraf, in a latest report, say while they expect CRR to be kept unchanged, the daily cash balance percentage could be reduced further to around 90 percent (in the April policy) to give banks more flexibility in managing their funds.
Kapil Gupta of Edelweiss Securities, like most analysts, expects a 25 basis points cut in the repo rate. Gupta has not ruled out the possibility of a higher-than-expected 50 bps cut as well, considering that the US Fed has turned dovish.
Though inflation has eased – to 5.18 percent year-on-year in February against 5.69 percent in January 2016 – Rajan will continue to watch inflationary trends closely. Abheek Barua, chief economist of HDFC Bank, believes there is an “an upside risk” to the inflation target of 5 percent for March 2017.
Secondly, Rajan might want to wait for a clearer trend to emerge for this year’s monsoon, which though predicted to be normal, is tough to assess at this stage.
“A cut beyond 25 bps could not only lower the real rate of return below RBI’s comfort range, but given the variety of risks and cautions that the central bank needs to consider, will not in our opinion be the prudent thing to do,” Barua and senior economist Shivom Chakravarti, say in a note to clients.
Naresh Takkar, managing director and CEO of independent credit rating agency ICRA, says: “Following the anticipated repo rate cut, ICRA expects banks to reduce their deposit rates expeditiously, particularly given the reduction in small savings rates, which pose competition to bank deposit mobilisation.”
“The same would transmit to lower lending rates by May 2016, under the new Marginal cost of Funds based lending rate (MCLR) regime”, Takkar says.