With inflation falling below 4 per cent and the government unable to boost spending or cut taxes due to fiscal deficit constraints, bankers and economists are expecting the Reserve Bank of India to cut the repo rate by around 100 basis points over the next few weeks to provide a fillip to economic activity.
“The fiscal headroom is very limited. Also, given that support from fiscal measures can remain limited on account of upcoming elections, more rate cuts from RBI are expected,” said Anubhuti Sahay, economist at Standard Chartered.
| THE STORY SO FAR Actual/potential release of primary liquidity since mid-September 2008 | |
| Measure/Facility | Amount (Rs.crore) |
| Cash reserve ratio (CRR) reduction | 1,60,000 |
| MSS unwinding | 63,045 |
| Term repo facility | 60,000 |
| Increase in export credit refinance | 25,500 |
| Special refinance facility for SCBs (Non-RRB) | 38,500 |
| Refinance facility for Sidbi/NHB/Exim Bank | 16,000 |
| Liquidity facility for NBFCs through SPV | 25,000 |
| Total | 3,88,045 |
| Memo: Statutory liquidity ratio (SLR) reduction is Rs 40,000 crore Source: Reserve Bank of India | |
The expectations of a rate cut have gone up after RBI Governor D Subbarao said in Tokyo that there was room for further rate cuts. In recent months, exports and industrial output have shrunk, the services sectors, the main growth driver over the last five years, has witnessed a slowdown and investment demand is coming down.
Since October, RBI has responded through a series of rate cuts and has reduced the repo rate – or the rate at which it lends to banks by 350 basis points – while the reverse repo rate – the rate at which it accepts surplus funds from banks – has been lowered by 200 basis points. Similarly, through a 400-basis-point reduction in the cash reserve ratio (CRR) – or the proportion of deposits that banks set aside – the central bank has injected Rs 1,60,000 crore into the system.
At its current level of 4 per cent, the CRR is 350 basis points lower than the level when inflation was last under 4 per cent, which was in December 2007. Similarly, the repo rate is at 5.5 per cent, while it was at 7.5 per cent in December 2007. At 4 per cent, the reverse repo rate is 200 basis points lower than the December 2007 level of 6 per cent.
The liquidity situation too is comfortable with banks parking over Rs 40,000 crore with RBI on Wednesday. In contrast, in December there was negligible surplus with banks as they were lending heavily to meet the credit demand of an economy growing at 9 per cent.
This year, the economy is projected to grow by 7.1 per cent this year, and by around 7 per cent next year. In January, the credit flow of scheduled commercial banks fell by Rs 22,000 crore on a year-on-year basis.
Through fresh rate cuts, the central bank will provide banks the right cues to lower lending rates. So far, banks have responded through a reduction in their prime lending rate by 50-200 basis points, with private and foreign banks being at the lower end of the band.
“Interest rates would be soft with inflation numbers showing a fall and the cost of funds for banks remaining low,” said Dena Bank Chairman and Managing Director D L Rawal.
The fall in inflation due to the easing of commodity prices gave RBI room for rate cuts, said IDBI Gilts Managing Director N S Venkatesh, while indicating that the central bank will announce a cut in the first week of March after factoring in the extent of growth moderation. He expected RBI to lower the repo rate by 100 basis points.
Suresh Tendulkar, chairman of the Prime Minister’s Economic Advisory Committee, did not put any number to where interest rates are headed but said, “Moving ahead, the system is likely to see a lower interest rate regime.”
“Given upcoming elections, the entire onus on stimulating growth now rests on monetary policy and we expect an additional easing of 100-150 basis points,” said Citi India economist Rohini Malkani.
Standard Chartered’s Sahay said that the repo rate would bottom at 4 per cent, the reverse repo rate at 3.00 per cent and CRR at 3.50 per cent by mid-2009. Over the next few weeks, she said, RBI would lower the repo rate by 100 basis points, while the reverse repo rate could be cut by 50 basis points. “Though, it cannot provide push, it can perhaps work to see that growth is not stalled,” Venkatesh said.
