RBI policy: More rate cuts likely ahead as MPC prefers growth to inflation

The credit policy this time is unique as for the first time there is a 35 basis point (bps) cut in the repo rate. This is a kind of compromise between the expected 25 bps cut and the more aggressive 50 bps which the market wanted. This has not had an immediate impact on G-Sec yields with the 10-year bond still at 6.31-6.33. The hope is that the transmission is faster to the lending rates, which would soften and help industry grow.

The previous rate cuts of 75 bps with accommodative stance have not quite worked to push up investment, and hence it would be interesting to see if this fourth cut changes the track. For sure some of the lending rates would come down, which may benefit home buyers or companies with debt, but for investment to pick-up, demand conditions need to change and turn positive. From a monetary standpoint, this had to be done to support growth as inflation is largely under control with favourable monsoon, crude prices and declining core inflation.

This entire chain of rate cuts and GDP growth brings to the fore also the effectiveness of monetary policy to stimulate growth. The process is long. First, the deposit rates need to come down, marginal cost of lending rate (MCLR) have to come down, bank spreads remain stable above MCLR, credit risk perception remain positive and more importantly, demand has to be robust for funding. This is why the link between interest rates and growth had been feeble. While models show that it works with lags of four – six quarters, there could be several developments that come in the way of growth.

The MPC has also brought down the projection of GDP growth of 6.9 per cent from 7 per cent, which is not significant but definitely does affect sentiment as any number less than 7 per cent is interpreted as weakness considering that growth was 6.8 per cent last year.  Moreover, for the first half, growth has been placed at 5.8-6.6 per cent. Growth in Q1 will be particularly low and is expected at less than 6 per cent by the market given the economic indicators available so far. There is, hence, a bet that the economy accelerates to 7.3-7.5 per cent in H2, which will mean a very favourable festival cum post-harvest season.

Going forward, it does look like that the MPC will be focusing more on growth than inflation that has been taken to be within the comfort zone for the entire year. The interesting conjecture that has to be made is whether there will be more cuts in this situation.

Growth will be lower this year, and hence, with the number being less than 6.6 per cent for H1, the question is will there be another rate cut before the second half begins? This does appear to be the case and a repo rate of 5.15 per cent in October looks more or less given and in case such weak tendencies continue, the policy rate can go at less than 5 per cent too during the year.

The core sector data which came for June at 0.2 per cent was dismal and indicates that industrial growth will be less than 1 per cent. This has probably been kept in mind when taking a rate cut call this time as inflation appears to be well within the 4 per cent band and presently is hovering at just above 3 per cent with a favourable outlook. The rupee concerns are still there and it looks more like that the external factors will drive the rupee lower towards the Rs 70.5-71/$ mark in the coming months – though a lot depends on how the FPI flows behave.

Madan Sabnavis is chief economist at CARE Ratings. Views are personal