Right time for a rate cut PDF Print E-mail
Monday, 03 October 2016 05:03
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With inflation collapsing, banks can lower rates now


With inflationary pressures ebbing and likely to ease further following the expected bumper harvest, there’s ample room for a rate cut on Tuesday. While RBI may want to wait till December to get a firmer estimate of foodgrain output and take into account a possible Fed hike, the best time is now since consumer inflation is on a downtrend and the chances of banks passing on a repo cut are very high right now. Thanks to a collapse in food inflation to 5.8% in August from 8% in July—this was, in turn, driven by a collapse in vegetables inflation to 1% from 14% over the same period—headline CPI fell to 5.1% in August from 6.1% in July. With vegetable inflation expected to go into negative territory over the next few months and pulses also likely to trend down, even the most cautious estimates now put the expected headline CPI rise at under 4.5% by March as compared to RBI’s target of 5%—the more optimistic see retail inflation nudging 4.5% as early as December. Indeed, there is near consensus that consumer inflation will stay below 4.5% throughout 2017. Which is why it may help to trim rates now, in the midst of the busy season, giving banks and borrowers a break and adding to the festive cheer.

To be sure, a 25-basis-points cut in the key repo rate—taking it to 6.25%—isn’t about to kick-start investments or even result in any significant rise in the demand for credit from the corporate sector. But what it will do is to drive down the cost of borrowings for banks, giving them some headroom to drop base rates, giving existing borrowers, especially those in the SME sector, a much-needed breather. While there has been some good news from industry—sales of cars, two-wheelers and tractors having been moving up—this has been restricted to select sectors as the disappointing headline numbers indicate. Industrial production, for instance, fell 2.4% y-o-y in July with deceleration across manufacturing, mining and electricity. And while there are issues with the data, the 30% fall in the production of capital goods—the ninth straight month of contraction—is far from encouraging.


While some relief to borrowers is called for, banks have been reluctant to cut rates as they are afraid it would hurt their margins; even though deposit rates have been lowered by about 100 basis points over the past year, the cut in loan rates hasn’t matched this. The good news is that interest rates in the bond and money markets have dropped sharply, both at the shorter end and the longer end, allowing at least the better-rated companies to mop up money at very competitive rates. That, of course, is thanks to the central bank ensuring there’s a lot more liquidity—between April and now, RBI has infused approximately R1 lakh crore via open market operations, driving down the yield on the benchmark by about 60-basis-points in three months. Given inflation is trending down, real interest rates will become even more positive, giving banks the flexibility to pass on a repo cut as they no longer have to worry about depositors pulling out their deposits.



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