The Reserve Bank of India is expected to cut its key policy rates by atleast 25 basis points in its upcoming monetary policy review on Tuesday, with inflation easing and weak investment and consumption demand.
The central bank which has cut rates by half a per cent or basis points between January and March this year has a window for monetary easing now, considering the risks of a possible increase in interest rates by the US Federal Reserve later this year and upside inflation risks.
According to Radhika Rao, Economist, DBS Bank, overall, beyond June’s rate cut, the room for further easing will narrow. “Key risks on the horizon include a gradual rupee depreciation in the quarters ahead, prospects of a weak monsoon (and related need for fiscal support) and commodity price rebound,” she said.
Despite US Fed Chair Janet Yellen’s remarks late last week that the Fed was on track to start raising US rates later this year, a rate hike is not expected at its June meeting. This could imply the RBI completing the rate cutting cycle in the first half of 2015 before the risks of a rate increase in the US heighten, she said. But if the fallout of El Nino is more contained than feared and oil prices remain steady and the US central bank refrains from raising rates, the RBI may have room to lower rates further in the second half of 2015.
“Lack of transmission from previous rate cuts into effective borrowing rates was a factor keeping the RBI on hold last time. “ said Richard Iley, chief Asia economist, BNP Paribas. The point being made is that there is a case for more stimulus.
The RBI will need to cut policy rates by another 50 basis points to nudge banks to cut lending rates by another 25 bps. A 100 bps cumulative policy rate cut will likely lead to a 50 bps lending rate cut eventually, but faster banks pass on the benefits, the better, given that growth momentum remains weak at this stage, said a Deutsche Bank report.The quantum and pace of transmission could have been faster if the RBI provided more liquidity support through Cash Reserve Ratio or CRR cuts, but going by the latest statements from RBI officials, it does not seem that the central bank is too inclined to follow that route, it said.
The transmission so far from policy rate to bank lending rate has been disappointing and is inadequate to boost real economic activity. “While a 50 bps policy rate cut would definitely enthuse banks to pass on the lending rate cuts faster, we don’t think RBI would opt for such an aggressive easing stance, given risks of a potential poor monsoon going forward,” Deutsche Bank said. The RBI is likely to continue with its incremental easing stance, which would pave the way for another 25 bps rate cut in August, which in our view would be the last rate cut in this cycle. Even with an additional 50 bps repo rate cut, real interest rate will be in RBI’s preferred target range of +1.5-2.0 per cent in 2015 and 2016.
Deutsche Bank says the current state and outlook for inflation, growth, and reforms appear to be consistent with further rate cuts in next week’s policy meeting. Regardless of what the official GDP figures indicate, a wide range of data (production, capacity utilisation, sales, trade, investment, credit growth, wages, revenue receipts, and corporate earnings) paint an economy still struggling to show any meaningful recovery and in all likelihood characterised by a large output gap.
“On inflation, while some of the key drivers (especially food and fuel) may not remain as favorable as they have been in the past year, the RBI’s inflation targeting glide path appears to be safe for both this year and next,” it says. On the reform end, especially in the fiscal structural area, the central bank will find the developments so far this year broadly in line with its wish-list. Against this background, experts says the case for further monetary easing is rather compelling. The RBI did not cut rates on April 7, citing lack of transmission from repo rate cut to bank lending rate cuts in the first quarter of 2015.
The central bank made it clear that banks will need to first cut their lending rates in response to the previous policy rate easing, and only then further policy rate cuts will be entertained. The push from RBI and the eventual improvement in the money market liquidity position, eventually led some of the key banks to cut the lending rates by 13-25 bps in April, thus satisfying one of the pre-conditions set by RBI for easing rates further.