Wednesday, 3 June 2015

RBI Delivers But Sings A Hawkish Tune.

As expected, in its second bi-monthly policy review of the new fiscal, the Reserve Bank of India (RBI) obliged with a much needed rate cut, with the repo rate slashed by 25 bps, the third such reduction in 2015.

The repo rate was cut to 7.25 per cent from 7.50 per cent while CRR was kept intact at 4 per cent. The case for a rate cut this time around was quite strong given the pullback in inflationary pressures thanks to a softening commodity price cycle that pushed consumer inflation, the RBI’s most watched gauge to a four-month low of 4.87 per cent in April 2015.

Moreover, Raghuram Rajan, the RBI Governor doesn’t seem to be too convinced over the strength of the economic recovery as he warned over tepid investment and demand, a fact evident by the dismal March quarter report cards delivered by India Inc., vindicating the rate cut verdict.

Further, Rajan also stressed against reading too much into the March GDP numbers that showed the economy grew 7.5 per cent, outsmarting China’s 7 per cent. However, the headline GDP figure may be subject to distortions while tumbling exports, a dip in April core sector output, and a slowdown in Gross Value Added to 6.1 per cent in the March quarter from 6.8 per cent in December quarter, signaled that the economy was in need of further stimulus support.

The rate cut would act as a catalyst for growth as falling interest rates aid a credit pickup and bolster a capex rebound. Softening interest rates would be a boon for rate-sensitive sectors such as banks, auto, realty and capital goods, with housing and auto loans likely to get cheaper, bolstering consumer appetite while lower credit costs may help stalled infra projects to take off.

That is where the good news ends with the RBI signaling a long pause before another rate cut as it warned of upside risks to inflation including a below par monsoon (now downgraded to 88 per cent of the Long Period Average) that can prop up food inflation, a rise in oil prices and heightened external volatility.

Rajan’s outlook for further policy easing summed up by his words “conservative strategy would be to wait” clearly indicate that this was probably the last rate cut for quite some time. However, if the rain Gods are kind to us and the Monsoon tops forecast, while the government continues strongly with its fiscal consolidation progress, we won’t have to wait longer for another rate cut.

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