The second off-cycle repo rate cut by the Reserve Bank of India (RBI) will help boost the momentum created by a very growth-oriented Budget. With a commitment to improve quality of expenditure, RBI seems to draw comfort that the fiscal impulses in the Budget are unlikely to stoke inflation (and, more importantly, inflation expectations).
In addition, the new Monetary Policy Framework Agreement makes the government "a partner" in the price stability effort. The following are some observations on the rate cut. First, the pivot for RBI's comfort in advancing the easing cycle seems to be the widely shared perception, that the growth focus of Budget is premised on leveraging limited public funds to raise private capital, rather than use a pure fiscal stimulus.
The policy measures spanned infrastructure, micro and small enterprises, agriculture and manufacturing. Even more than allocation of funds, the policy framework - tax, PPP frameworks, regulations and approvals, disclosure, resolution etc., is being reformulated to facilitate greater private and foreign investment. This, in particular, should encourage infrastructure projects, where implementation problems have had a large role in the current slowdown.
Second, the RBI rate cut, together with the Budget proposals, will greatly improve sentiment. Investors had recognised India's potential for a while, and its macroeconomic fundamentals are comparable or superior to its Emerging Markets peers. Monetary, fiscal and manufacturing policy will now mesh together to push a capex and growth recovery.
Accommodative policy and improved sentiment will drive investment much sooner than any single measure, taken in isolation, would have. Third, in response to the repo rate cuts and liquidity infusions, cuts in banks' lending rates are likely to gather momentum in April, early in FY16. Liquidity is conventionally tight in the fourth quarter, and particularly March, with surging demand for credit and large advance tax outflows. This eases in April, with the government spending its cash balances. In the meantime, banks might cut deposit rates further, aligning with the change in repo rate, facilitating cuts in lending rates.
V Srinivasan
Executive Director (Corporate Banking), Axis Bank
