Rate cut likely in Urjit Patel’s debut policy next month

The possibility of a rate hike in December by the US Federal Reserve – the central bank of the United States that controls the country's money supply – and the expectation of the inflation falling further in India, may give adequate room for the new Reserve Bank of India (RBI) governor Urjit Patel to go in for a 0.25% cut in the repo rate (the rate at which RBI lends to banks for a short term) when he unveils his first monetary policy on October 4.

This could then translate into softer lending rate by banks to customers as the busy season sets in.

Bankers have been saying that if credit growth picks up, then they could give lower rates as the volumes will make up for what is lost in margins.

Urjit, who is perceived as an inflation warrior, will have to lower his guard as food prices are falling faster than earlier anticipated and with inflation likely to hit 4% by December 2016.

Economists say that the governor will use the space available to reduce rates, differing only on the timing of the cut with majority saying that October will see a reduction in rates. A few of them, however, think he could wait until December to be definite about the movement in food prices.

Abheek Barua, chief economist, HDFC Bank, told dna, "We expect the September numbers for inflation to fall below 5%, partly due to the base effect. So there is a good opportunity to cut rates by 0.25% in the October policy and then, there could be a pause with a possibility of a Fed rate hike in December. Domestic growth continues to be patchy as industry is sitting on excess capacity but lowering of interest rates will bring down one of the components of cost and perhaps encourage industry to invest."

The RBI has been infusing liquidity into the markets to ease the borrowing cost. This financial year RBI has infused Rs 90,000 crore into the money markets by buying back government bonds held by banks and other market participants.

Saugata Bhattacharya, chief economist at Axis Bank, told dna, "The inflation has fallen lower than the expected 5.2%, providing a good opportunity to cut interest rates. But we need to carefully watch the food prices and the impact of the rains. Then, there are other factors... the monetary policy committee (MPC) is yet to be formed and a deputy governor post is also lying vacant. We need to see how these factors will play out. In the meantime, RBI may continue to infuse liquidity to bring down the rates."

RBI has a target for CPI (consumer price index) at 5% by March 2017 and a long-term target of 4% with a band of 2%. Some economists like Soumya Kanti Ghosh from State Bank of India (SBI) expect the long-term target of 4% to be achieved by December. "But the food prices have been so erratic that it needs to be seen whether this is sustainable," said Ghosh pointing out that the difference between CPI and WPI, which was as much as 8.70% in October last year, declined to 2.52% in July 2016.

Ghosh expects that the RBI may go more aggressive on liquidity for rate transmission in the second quarter of 2016-17. "Though the rate cut may happen either in October or December, we believe the possibility of a rate hike by US Fed in December may prompt the RBI to cut rates in October," Ghosh said.

While expecting a rate cut on October 4, rating agencies like Crisil warn about the upside risks – such as the high inflation in pulses, which saw double-digit growth for 14 consecutive months. Services sector inflation continues to be high in various segments like education and medical services.