The Reserve Bank of India (RBI) has left key policy rates unchanged, much to the chagrin of bankers but its tone is a lot more upbeat than it has been through the year. So, the markets could be missing the bigger message here. While cutting rates is almost a given (albeit from next year), the important thing to note is that the central bank’s tone has turned positive, after having played Dr Doom for months.
At this point in time, rate cuts without a commensurate pick-up in economic growth would be pointless. RBI has set the stage for a January rate cut, by highlighting the green shoots. There are indications that both agriculture and manufacturing activity is on the mend. In its mid-quarter review, RBI says: “The manufacturing PMI rose moderately in November as order book volumes expanded. While the services PMI declined from a month ago, expansion in new business and order book volumes suggests positive sentiment about increasing activity in the months ahead. In the farm sector, rabi sowing coverage is expanding steadily, improving the prospects of agricultural growth.”
Even as downside risks to the global economy remain, like fiscal cliff in the US and weakness in the Euro zone, RBI has acknowledged signs of stabilisation in the developed world and emerging economies are returning to the orbit of higher growth. This also indicates that demand from the external sector will improve. The central bank expects domestic growth rate to improve in the second half of FY13. Also, policy initiatives by the government would give the much-required boost to business sentiment and investment climate.
Despite all the positives, inflation remains a challenge. Leif Eskesen, chief India and Asean economist at HSBC Global Research, says: “Inflation risks are still tilted to the upside. Policy rate cuts are, however, possible, but the room is limited and we currently only expect 50bps in rate cuts next year. Rate cuts would largely depend on the extent to which inflation risks begin to recede.” A section of economists believes the policy statement is dovish and the central bank will look at core inflation as a key trigger for policy action. Core inflation (non-food inflation) has come down to a three-year low of 4.5 per cent. While most of the market is building in a 50 basis point rate cut over 2013, Richard Iley of BNP Paribas says: “Looking into FY2014, the scope for any further reductions in the policy rate will largely be determined by the government’s ability to decisively rein the fiscal deficit.”
