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Markets bet on Subbarao surprise

Rates of certificates of deposit and overnight indexed swap suggest there is hope for a rate cut

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Reserve Bank of India (RBI) Governor has made a series of hawkish statements since the on June 18, but market participants are still betting on the governor’s inclination to surprise the market.

While the overall feeling still is that the central bank will hold the rate during the first quarter review of the monetary policy, scheduled on July 31, many feel there is still the chance of a rate cut.

In a note titled ‘Could the surprise yet again and cut rates on July 31?’, Citi India economist says there are three possible reasons for this: (1) The government raises fuel prices, thus indicating some commitment to addressing the fiscal situation; (2) justifying the rate cut in the light of a likely revision to its annual GDP (gross domestic product) estimates (RBI’s 2012-13 financial year GDP estimate is currently at 7.3 per cent); and (3) comfort on stabilising core inflation and the rupee.

During the April policy review, when market expectation was divided between no rate cut and a maximum 25-basis-point (bp) rate cut, as inflation was still high, Subbarao pleasantly surprised the market by delivering a 50-bp rate cut to boost growth and on the back of moderation in core inflation.

What the central bank considered for policy action
Date Policy Expectation Action Reason
Jul 26,11 First quarter monetary 
policy review
25-bp rate rise Rate rise by 50 bps High WPI
Sep 16,11 Mid-quarter policy review 25-bp rate rise Rate rise by 25 bps High WPI, CPI
Oct 25,’11 Second quarter monetary 
policy review
No repo rate rise  Rate rise by 25 bps High WPI
Dec 16,’11 Mid-quarter policy review No change in rate 
but CRR cut expected
No change  Moderation in 
Jan 24,’12 Third quarter monetary 
policy review
CRR cut  CRR cut by 50 bps Moderation in 
growth, WPI
Mar 15,12 Mid-quarter policy review Repo cut  No change  WPI moderated 
though sticky
Apr 17,’12 Annual monetary  
& credit policy
0-25-bp rate cut Rate cut by 50 bps Fall in growth, WPI 
though CPI was high
Jun 18, ‘12 Mid-quarter policy review  25-bp repo rate cut No change  High CPI though WPI 
WPI: Wholesale Price Index; CPI: Consumer Price Index; CRR: Cash Reserve Ratio; bps: Basis points        Source: RBI

In the next policy meeting, in May, the expectation was that the governor would continue with a pro-growth stance, amid fall in crude oil prices. But Subbarao opted for status quo, with an extremely hawkish statement.

The Reserve Bank of India governor acknowledged headline inflation had moderated but pointed out consumer price inflation (CPI) was in double digits, for the first time since the index was introduced in January.

Market rates seem to have factored in a positive surprise from the central bank this time. The overnight indexed swaps, that reflect market perception of interest rates, have softened to below the repo rate during the course of the first quarter.

“These signify that markets are expecting some kind of easing. Possibility of rate cuts is dim in the backdrop of poor monsoons but perception of lower remain,” said a senior treasury official from a large public sector bank. “It is also being reflected in the cash market.”

The rates on (CDs) have fallen to below nine per cent recently from over 11 per cent levels at the beginning of the current financial year. Comfortable liquidity conditions and low credit demand have led to a fall in issuances from banks.

Daily liquidity injection by RBI through the repo window is now within its comfort zone of one per cent of net demand and time liabilities. Today, banks borrowed Rs 24,010 crore through RBI’s liquidity adjustment facility.

However, an element of unpredictability is abound. “A rate cut looks difficult when inflation is high and monsoons are not up to the mark. The market consensus is that the central bank may hold rates but one cannot predict the policy action,” said a senior banker.

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