Little chance of an RBI rate cut

September 24, 2014

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

At the Reserve Bank of India (RBI) monetary policy review in August, India’s policy parameters looked encouraging but the central bank was not eager to make any significant change to monetary policy – and none at all to the interest rate. Since then, perspectives have changed. And yet, it is unlikely that the RBI will make any cut, though desirable, to the interest rate.

 Reserve Bank of India (RBI) Governor Raghuram Rajan attends a news conference in New Delhi March 7, 2014. REUTERS/Adnan Abidi /Files

In August, there was a little more cheer. The RBI’s assessment was that global economic activity was picking up, investor appetite had buoyed the financial market and there was a flood of portfolio investment into emerging market economies.

After stagnancy in industry, sentiment was reviving in India and growth in the manufacturing sector had firmed up. The same was true for exports. Retail inflation had eased for a second consecutive month although upside risk remains.

Based on that assessment, the RBI did not reduce the repo rate or the CRR but cut SLR by 50 bps to 22 percent.

Commercial banks had a different view, possibly because of the unpleasant realities they had to face. Money was not coming back from borrowers on time and banks had to hold huge NPAs. Balance sheets looked a little unbalanced. Growth in demand for credit had also dropped. Some banks led by the State Bank of India increased the base rate and reduced the interest on deposits, although the repo remained stuck at 8 percent.

In the last two months, economic parameters have changed further, both internationally and domestically. The U.S. FederalThe Reserve Bank of India seal is pictured on a gate outside the RBI headquarters in Mumbai Reserve is keen to increase the interest rate, although its timing is still undecided. The European Central Bank and Bank of Japan have taken the interest rate into the negative zone, hoping to stimulate investment and growth.

It is India’s domestic economy that presents, once again, a distorted picture. Industrial growth, which had revived in the April-June quarter, collapsed in July for want of stimulus. The only sector that performed well was electricity generation. But the capital goods industry and durable consumer goods industry have woefully underperformed, indicating that demand is very weak. The stock market, which had bounced a bit too high, lost 1.5 percent in a single day on Sept. 23. The bulls are losing their grip. What is more relevant for policymaking by the RBI is that inflation going by the wholesale price index dropped precipitately to 3.7 percent – its lowest in five years – but inflation at the retail level remained high at 7.8 percent.

For the RBI, consumer inflation is the representative measure of inflation. No wonder Governor Raghuram Rajan was quick to mention that there had to be stability before the repo rate can be reduced. The next bimonthly review of monetary policy is on Sept. 30 and it seems unlikely that the RBI will change its stance or policy.

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