RBI monetary policy review: Rate cut decision to be based on Budget, note ban impact

Most analysts and bankers are expecting a 25 bps reduction in the key policy rate.

Written by George Mathew | Mumbai | Updated: February 8, 2017 4:31:50 pm

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When the six-member Monetary Policy Committee (MPC) of the Reserve Bank meets on February 7 and 8, their decision on a possible rate cut will be influenced by the signals from budget, lingering concern about the impact of demonetisation on growth and a rather benign inflation outlook despite rising fuel prices.

Most analysts and bankers are still expecting a 25 basis points reduction in the key policy rate — the repo rate — to 6 per cent on February 8 when Governor Urjit Patel will unveil his third policy review. “We are still calling for a 25 bps repo rate cut. Since the last RBI policy, CPI inflation has surprised to the downside both in November and December, which has improved the chances of meeting the 5 per cent March 2017 CPI target appreciably,” said a report by Deutsche Bank.

WATCH VIDEO | Reserve Bank Of India Keeps Repo Rate Unchanged

 

“Apart from the policy details, the markets are also keen to hear about the demonetisation impact and numbers, especially how much money has come in and gone out. It remains to be seen whether there will be consensus in MPC this time,” said a senior official of a public sector bank. The RBI is yet to provide details of the total amount deposited at the end of the 50-day demonetisation drive.

“We grow more confident about our call that Budget 2017 will help to cut lending rates by 50-75 bps by September to offset the impact of the demonetisation shock in the second half of 2017,” said a Bank of America Merrill Lynch Global Research report. Patel, backed by all the six MPC members, had kept the repo rate unchanged in the December 7 policy review. The RBI had cut repo rate by 25 bps in the October 4 review in 2016, the first by Patel as the Governor.

“We expect the RBI to use the additional room that has opened up and cut the repo rate by 25 bps in February, rather than in April. However, the extent of further cuts in the repo rate will remain restricted and be conditional on uncertainties in the global commodity cycle, Brexit and Trump related volatility in the global financial markets and hence, likely depreciation pressures on the rupee,” said IDFC Bank Chief Economist, Indranil Pan.

Soon after the demonetisation drive ended, commercial banks cut their lending rates by about 80-90 bps in one clip earlier this year. It is unlikely that they will reduce the rates any further without the policy rate being lowered further. While the banking liquidity remains comfortable, incrementally there will be outflows as withdrawal restriction is lifted in the period ahead. “Some more reduction in lending rates may be required to support growth in our view, for which the RBI should consider easing the policy rate next week, given that monetary transmission takes place in India with a significant lag,” Deutsche Bank said.

However, a section of bankers feel that the RBI may not want to cut the policy rate too aggressively in the period ahead, but still want to deliver lower market rates by making liquidity more abundant. “In such a scenario, RBI will allow liquidity to move into surplus territory in the money market, which will push the overnight call rate to the lower end of the LAF corridor (reverse repo rate), leading to an effective easing of rates.
This may not be a bad idea in case RBI is not sure about the medium term inflation outlook, but still wants to keep rates lower due to growth considerations,” said an analyst.

On December 7, while keeping rates unchanged, the RBI Governor said, “it is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs while setting the monetary policy stance. On balance, therefore, it is prudent to wait and watch how these factors play out. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance.”

The RBI has made it clear that it will strive for achieving consumer price index inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth. However, analysts had said India’s overall monetary conditions — which reflect the combined impact of monetary stance based on changes in real interest rate and real effective exchange rate — remain in a restrictive zone, even after 175 bps rate cuts from the RBI, mainly due to a persistent appreciation of rupee in real terms.

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