Tuesday, 21 February 2017

5 factors why RBI may go for a 25 bps cut but be ready to be surprised

A kneejerk reaction on Dalal Street cannot be ruled out in case the central bank decides to maintain status quo on rate this time again.


NEW DELHI: The stars are aligned for an interest rate cut by the Reserve Bank of India (RBI) on Wednesday, but the central bank is known for delivering surprises.

A kneejerk reaction on Dalal Street cannot be ruled out in case the central bank decides to maintain status quo on rate this time again.

More than 1,000 Twitteratis in an ETMarkets poll have voted in favour of a 25 bps rate cut by the Reserve Bank of India (RBI) on Wednesday. As many as 43 per cent of participants, who voted in the survey, said RBI could cut rates by 25 bps, while 40 per cent expect no rate cut and 17 per cent foresaw a rate cut of up to 50 bps.

The domestic macro-economic backdrop clearly calls for continuous monetary easing, especially because the fiscal impulse to growth remains modestly negative.

“The global scenario remains a tad uncertain, but we believe it does offer a window of opportunity to RBI to act. Overall, we expect a 25 bps rate cut by the central bank on February 8,” 
Edelweiss Securities said in a report.

Going by the buzz on Dalal Street as well as what economists are saying, we have collated a list of five factors that may make RBI go for a rate cut.

A supportive Budget: The Union Budget announced on February 1 had no surprises. The government remains committed to continued fiscal consolidation from 3.5 per cent of GDP in FY17 to 3.2 per cent in FY18.

“The assumptions underlying the 
fiscal deficit target were broadly realistic, barring a few ‘quibbles’, such as a rich disinvestment target, and there was an improvement in the quality of expenditure,” Pranjul Bhandari, Chief India Economist at HSBC Securities and Capital Markets (India) Private, said in a note.

“The fiscal impulse from the Budget alone is likely to be negative, leaving some space for RBI to remain accommodative,” she said.

“On interest rates, while it is a close call, we expect RBI to cut by 25 bp. We expect RBI to discuss its forecasts, but continue to hold on to its accommodative stance,” Bhandari said.

Benign inflation: The macro backdrop for the forthcoming 
monetary policy review is conducive for continued monetary easing. Inflation remains low and contained at 3.4 per cent, which is below RBI’s target.

Retail inflation is likely to be well below RBI’s target of 5 per cent this financial year, as 
demonetisation would discourage any headwind on the price front, the Economic Survey for 2016-17 said.

During April-December, retail inflation averaged 4.9 per cent and has displayed a downward trend since July. Retail inflation eased further to a near three-year low of 3.41 per cent in December, reflecting weak demand, as consumers grappled with cash crunch following demonetisation.

Though it may rise in the coming months, it will still undershoot RBI’s indicative trajectory

Stable global environment: In its December policy review, one of the reasons cited by RBI to hold policy rate was Fed’s tightening stance and the associated strength seen in the US dollar. Since then, the USD has stabilised and, in fact, weakened to some extent.

If RBI believes there is space for a rate cut, then it should move quickly. Inflation is low thanks to food prices, the Budget was disciplined and the dollar is steady.

“At the global level, though uncertainty persists, the situation still offers space as the US Fed is not in a hurry to raise interest rates immediately and the US dollar is showing a weakening bias,” Edelweiss Securities said in a report.

“Moreover, the rupee is overvalued. In our view, this backdrop warrants a 25 bps rate cut,” it said. The Fed is not in a hurry to raise rates. Perhaps, the next move by the US Fed could happen around mid-2017.

Comfortable fiscal math: The economy is certainly stabilising after the demonetisation shock, but still aggregate demand remains weak with private capex particularly anaemic.

The central government’s aggregate expenditure growth is going to moderate sharply to 6-7 per cent YoY in FY18 compared with 12-14 per cent in the past 2-3 years. “The fiscal math presented in the Budget is quite credible, which should also be comforting for RBI,” Edelweiss Securities said in a report.

Note ban has hurt growth: The Economic Survey released last week pointed out that demonetisation would have both short-term costs and long-term benefits, but growth will get hit in the short term.

To keep the momentum going, RBI might give a booster by cutting interest rates by 25 bps to facilitate further transition.

“Given the government’s intention to adhere to fiscal prudence despite the compulsions of supporting a slowing growth momentum, we expect RBI to deliver a 25 bps rate cut in the forthcoming monetary policy,” Kotak Institutional Equities said in a note.

“We continue to see scope for 50 bps rate cut through FY18,” it said.

The domestic economy should grow between 6.75 per cent and 7.5 per cent in the financial year beginning on April 1, 2017, said the Economic Survey for 2016-17 last week.

The survey’s GDP growth figure for this financial year is lower than 7.1 per cent the Central Statistics Office had forecast earlier this month.