Consensus is on RBI staying put on rates

There may not be immediate relief from high interest rates for customers as the Reserve Bank of India (RBI) is unlikely to slash policy rates when it unveils its third credit policy of the financial year tomorrow. Amid spike in food prices in India and slowdown in global growth, especially in China, and rate hikes by US Federal Reserve later this year looming large, India needs to keep its interest rates attractive so that foreign investors stay invested in the country, say experts.

At this point, the possibility of oil prices remaining subdued is the only comfort for the central bank. Adding to the RBI's woes is the resistance from banks for lowering their lending rates, which, in effect, defeats the central bank's intent of lowering its key policy rate (Or the repo rate, at which RBI lends overnight money to commercial banks in India). 

Despite, RBI slashing rates by a cumulative 0.75% since January 2015, banks on an average have reduced their base rates only by 0.25% and deposit rates by 0.50%. Credit growth has also slipped below 10% from the medium-term average of 21%, limiting the transmission of RBI rate cuts into lending rate cuts. "Rains remain erratic and food prices spiked in June, though prices have eased in July. Growth recovery indicators provide mixed signals, global commodity prices have fallen again after a momentary rise, monetary transmission remains incomplete, and the timing of the Fed's lift-off depends on incoming data. In light of these unclear trends and unfolding data, we expect the RBI to remain on hold on August 4 and reiterate its data-dependent stance," Pranjul Bhandari, economist with HSBC, said in a report.

Wholesale Price Index (WPI) inflation has remained negative for the last eight consecutive months and stood firm at negative 2.4% in June. Consumer Price Index (CPI) inflation, which makes the basis for RBI's rate-related policies, remains lower than RBI's guided path target of 6%. Growth in headline CPI inflation accelerated to an eight-month high of 5.40% year-on-year in June 2015 compared with 5.01% yoy in May 2015, predominantly due to higher food inflation and diminishing base effect. Price increases in some protein-rich items such as pulses, milk and meat led to food inflation rising to 5.5% in June from 4.8% in May.

Sunil Kumar Sinha, director - public finance & principal economist, India Ratings, said, "The key to defining the magnitude of rate cuts will depend on incoming data on CPI inflation compared with RBI's expectations of inflation trajectory. Given the acceleration in the June headline CPI inflation and the increase in core CPI for the third consecutive month, RBI is likely to see how the monsoon season pans out and keep rates on hold in the August monetary policy meeting. We expect the average the headline CPI inflation to come in at 5.4% in fiscal 2016, which we believe should create room for RBI to lower rates by a further 25 basis points during the second half of 2015-16."

Deutsche Bank said in a report, "We expect the RBI to maintain an unchanged stance in the policy review, though we are not giving up hope yet for another 0.25% rate cut in this financial year. RBI's guidance will be interesting, given the uncertain local and global growth and inflation environment." Ranjan Dhawan, chief executive officer and managing director, Bank of Baroda, said, "We don't expect the RBI to cut rates as there is no data that is providing a positive signal.With uncertainties on global and domestic growth we are of the view that RBI would wait and watch the situation before moving on the rate front."

The silver lining, however, is that Brent crude prices are down 17% since early June, which has pushed down domestic diesel and petrol prices by 16% yoy and 12% yoy, respectively. The probability of US Fed hiking rates, a slowing Chinese economy, sluggish economic recovery in advanced countries, and still favourable supply-side developments are factors that will likely keep Brent prices range-bound, say experts.