RBI has leeway for a 50bps repo rate cut

The Reserve Bank of India (RBI) can easily frontload its rate cuts for this fiscal, as there are enough positive data points to back the actions.

RBI’s annual monetary policy statement for this fiscal is scheduled for May 3, where the central bank will give out forecasts on economic growth, inflation, current account deficit, bank deposit and lending growth and money supply growth during this fiscal.

Markets should not rule out a 50 basis point (bps) repo rate cut that day, though the RBI had sounded caution on further cuts in its March policy review where it cut the repo rate by 25 bps. At that time, the central bank was worried on food inflation, which was trending at 11.38%, leading to higher consumer price inflation and current account deficit (CAD) hitting record high levels.

RBI’s concern on inflation and CAD remains, but indications are that both the measures are likely to trend down, going forward.

Meanwhile, data on index of industrial production (IIP) growth and vehicle sales growth point to a sharply weakening economy. Outlook for liquidity is also better than what it was in the previous fiscal and the RBI would not be required to buy government bonds to shore up system liquidity.

Inflation based on the wholesale price index (WPI) fell to a 40-month low of 5.96% in March 2013. Going by January revision trends, where the WPI was revised upwards from 6.62% to 7.31%, the March inflation number is also likely to be revised upwards.

Despite the upward revision, however, inflation is likely to be around 6.5% levels with the outlook for inflation coming off more positive than negative. Fall in prices of commodities from oil (down over 6% on-month) to gold (down 6%) suggest that global demand is weakening and inflation expectations are down. Food inflation has come off from levels of 11.38% seen in March to levels of 8.73%. Manufacturing inflation is down from 4.51% to 4.07%.

Consumer price inflation (CPI) fell to 10.39% in March from 10.91% in February. Fall in food inflation is expected to bring down the CPI further. Lower inflation expectations are a plus factor for the RBI in its efforts to boost economic growth.

IIP growth for February came in at 0.6%, down from 2.4% seen in January. IIP growth for the April-February period was at an anaemic 0.9% against levels of 3.5% seen the previous fiscal.

Demand has cooled in the economy with passenger car sales for the last fiscal showing negative growth for the first year in a decade. Demand outlook is not positive, given falling trends in consumer durables, which showed negative growth for February.

CAD came in at record highs of 6.7% of the gross domestic product (GDP) for the third quarter last fiscal. CAD is expected to trend down from record levels as a weak economy lowers import growth. Falling prices of oil and gold is highly positive for the CAD coming off.

Liquidity outlook for this fiscal is positive. RBI’s measure of liquidity is based on banks borrowing and lending in the daily liquidity adjustment facility auction. Banks are borrowing around Rs 85,000 crore from the RBI, but given the fact that the government is carrying a cash balance of around Rs 80,000 crore that is parked with the RBI, system liquidity is almost neutral. RBI will get comfort from the fact that it is not required to buy government bonds to shore up liquidity.

Banks have raised Rs 3.74 lakh in deposits in March and have plenty of liquidity. Banks’ demand for government bonds is high in April given that they need to maintain statutory liquidity ratio of 23% on incremental deposits. No wonder, government bond auctions are seeing good bidding interest, with bid-to-cover ratios of 4 and above. RBI need not worry about pushing government borrowing this fiscal.