The RBI had asked the government to cut subsidies and help fiscal consolidation but coalition politics made the decision-making difficult for the government for some time.
While inflation and inflationary pressures are major concerns of the Reserve Bank of India (RBI), bankers and the market expect a rate cut of 25 basis points to balance growth and inflation as envisaged by the government.
The RBI had asked the government to cut subsidies and help fiscal consolidation but coalition politics made the decision-making difficult for the government for some time. Now a determined government, since the change of guard at the Finance Ministry, has taken some bold decisions. The government expects that the measures announced by it and the central bank will stimulate the economy and reduce fiscal and current account deficits (CAD).
Since Mr. Chidambaram took over the Finance Ministry last August, he was able to cheer up the stock market substantially. The benchmark 30-share sensitive index (Sensex) shot up from 17257.38 on August 1, 2012, to 20103.53 on January 25, 2013. In this period, more than $16 billion foreign institutional investor (FII) inflow was recorded. A rate cut by the RBI would provide an essential euphoria in the market. The departure of Subir Gokarn, the former Deputy Governor of RBI, who guided the policy rates, has raised expectations of a cut much before the end of the fourth quarter. Dr. Gokarn had always maintained that inflation was a major worry for the central bank as he had said “Runaway inflation could be much worse in the long-run.”
Rate cut hopes
Inflation rate, especially the wholesale price index (WPI), is not in the comfortable level of 5-5.5 per cent which the central bank was anticipating for a long time. This is at present hovering around a “stubbornly high” level of 7-7.5 per cent. Retail inflation (based on consumer price index) is above 10 per cent.
The recent statement of the RBI Governor D. Subbarao that “inflation remained too high” hit the hopes of a sharp cut of 50 basis points in policy rate, after nine months.
The RBI’s last rate cut was in April 2012 when it reduced the repo rate by 50 basis points from 8.5 per cent to 8 per cent. Meanwhile, the RBI had brought down the Cash Reserve Ratio (CRR) from a high of 6 per cent to 4.25 per cent pumping liquidity to the banking system.
The repo rate is the rate at which banks borrow funds from the central bank. Cash Reserve Ratio is the portion of deposits banks are required to maintain with the Reserve Bank of India. The RBI had forecast — which was unusual and surprised market participants — in the second half of monetary policy review in October that there was a “reasonable likelihood of further policy easing in the fourth quarter of this fiscal year”.
The central bank reiterated that in its mid-quarter review in December “Inflation patterns and projections provide a basis for reinforcing our October guidance about policy easing in the fourth quarter.” The yield of benchmark 10-year Government Securities (G-Sec) has fallen below 7.9 per cent from above 8 per cent prevailed in mid-December in anticipation of a rate cut.
However, the RBI said risks to inflation remained. Even though it said that “the policy emphasis shifts towards growth”, the policy stance would remain sensitive to two risks: falling growth and rising inflation.