Poor rains, oil, US Federal may sour rate-cut party

The Reserve Bank of India (RBI), which cut the repo rate by 25 basis points on Tuesday, dropped broad hints for a pause in the rate-easing cycle.

Rising crude oil prices, a poor monsoon and the US Federal Reserve rate hike later this year may be a dampener for lower interest rates in India, according to the central bank.

The RBI governor Raghuram Rajan said the central bank is no cheerleader for the economy and "can only do so much" to enhance the economic growth.

Asked why he did not go for a 50 basis points cut to spur investment, Rajan curtly said RBI is not a "cheerleader".

"The RBI is not a cheerleader. There are other people in the economy who can play the role of a cheerleader. Our job is to give people confidence in the value of the rupee, in prospects of inflation, and having established that confidence, create a longer-term framework for good decisions to be made. Everytime an exporter comes to me and says that stability has been very valuable for us to make decisions, that reinforces my view that these are our main roles, not to act as a booster shots or cheerleaders," Rajan said.

"I would characterise the policy today as neither conservative or aggressive. In some sense, it is a Goldilocks policy, just right given the current situation," Rajan said in a post policy media conference. A Goldilocks economy sustains moderate economic growth and low inflation, which allows a market-friendly monetary policy.

After lower global oil prices helped reduce inflation in India, crude had been on a rebound in recent months. "If prices keep climbing, that could add to inflationary pressure," Rajan said.

Pranjul Bhandari, chief India economist, HSBC, said, "The risk is poor monsoon rains and the nature of the government policy reaction. If rains are disorderly, today's rate cut is the last one for now."

Industrial production has been recovering unevenly. The sustained weakness of consumption spending, especially in rural areas as indicated in the slowdown in sales of two-wheelers and tractors continues to operate as a drag. Corporate sales have contracted. The disappointing earnings performance could have been worse if not for the decline in input costs. Capacity utilisation has also been falling in several industries, indicative of a slack in the economy, said the central bank.

The 14% service tax is another factor why the central bank revised its inflation expectation to 6% from 5.8% in January 2016.

Added to this is the third advance estimates of the ministry of agriculture that indicated a contraction in foodgrain production by more than 5% in relation to the preceding year's level with damage to crops like pulses and oil seeds where buffer foodstocks are not available in the central pool.

Chanda Kochhar, managing director and CEO, ICICI Bank, said, "The uncertainties cited in the policy statement present a pragmatic evaluation of economic conditions warranting a guarded approach, particularly with regard to risks to inflation and impact of monsoon. In summary, the policy stance is in alignment with the current economic conditions and the issues that require structural policy changes."

Arun Tiwari, chairman and managing director, Union Bank of India, said the rate action is a tightrope call given the deficient rains outlook and external eventualities like the US Federal lift off and crude prices firming up. "With the RBI expecting inflation to go up to 6% by January 2016 which is also its target, real interest rates are at the neutral level limiting further cuts in the year," he said.