Following a slew of positive measures by the government last week, the clamour for a reduction in the repo rate had increased. However, the persistently high inflation rate led RBI to desist from doing so.
Pressures on inflation are likely to increase in the short term due to deficient monsoons, high non-food manufactured product inflation and the impact of the rationalisation of diesel and cooking gas prices. Further, QE3 (the US Fed’s new quantitative easing move) could have a two-way impact on India.
On the one hand, it might be inflationary as commodity prices, particularly oil, could see some upward spiralling. On the other hand, this risk could be offset by an appreciating rupee due to increased capital inflows and a weaker dollar.
The reduction in the Cash Reserve Ratio (CRR) by 25 basis points reflects RBI’s foresight.
Though liquidity is currently at a comfortable level, the year-on-year deposit growth is sluggish at under 15 per cent. It is, thus, prudent to buffer the system now to ensure no strain in the second half of the year, when credit growth typically picks up. For banks, a CRR reduction increases its margins and profits, which in turn gives headroom to banks to reduce their Base Rates. Hence, the possibility of a reduction in interest rates by banks has increased.
In aggregate, despite the slowdown in the economy, the risk of a rating downgrade for India now appears to be receding. The measures taken by the government are welcome and bold, given the logjam over several months. The proposed disinvestments and the measures taken to reduce fuel subsidies (assuming no roll back) augurs well for the fisc. These factors will give RBI leg room for further monetary easing in the coming months.
Keki M Mistry
VC & CEO, HDFC Ltd