It is almost certain that the Reserve Bank of India (RBI) will wield the knife on its repo rate, given the salutary convergence of domestic and global factors, when it reviews monetary policy on April 5.
The only question is, will it be 25 or 50 basis points?
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An important factor influencing RBI's rate-cut decision will be the fiscal restraint shown by the government. RBI has for long argued that high deficits are responsible for the persistence of inflationary pressures and limit the scope to lower interest rates.
By targeting the fiscal deficit at 3.5 per cent of the gross domestic product (GDP), the government has created space for RBI to slash. The lowering of the fiscal deficit target for this financial year has already had a constructive impact in the bond market, where 10-year government yields have come off by more than 20 basis points since the announcement of the Union Budget on February 29, 2015.
Current growth-inflation dynamics, too, favour a rate cut. Consumer Price Index-based inflation at a lower-than-expected 5.2 per cent in February puts it firmly on a glide path to five per cent by the end of this financial year. Last financial year should end up with an average CPI inflation below that watermark.
Given weak growth prospects in China and marking down of global growth for 2016, crude and commodity prices are expected to remain low. Additionally, this year is likely to see a La Nina event that lavishes rains. A normal monsoon this financial year will help keep a tab on food inflation.
Excess capacity in the manufacturing sector means pricing power remains weak. But, industrial production data continues to be sluggish. Add to that subdued private investment climate and the case for an accommodative monetary policy gets strengthened.
Industrial production in the past two months (January and February, 2016) averaged -1.4%.
The latest statement by the US Federal Reserve chairperson Janet Yellen that there is no hurry to raise rates in the US makes it easier for RBI to cut.
In my opinion, RBI should cut repo rate by 25 basis points on Tuesday and deliver a similar cut sometime later. Anything more will be driven by inflation data and the actions of the US Fed.
The author is chief economist, CRISIL Ltd
