A rate cut from RBI finally came after a three-year hiatus and the extent of easing surprised everybody. With below-trend growth and substantially lower core inflation, there was definitely a case for adjusting policy rates lower but 50bps at one go was a bold move. We think prodding banks to lower lending rates through a decisive move was the main reason for this larger-than-anticipated rate cut. Also, with headline inflation still hovering at 6.7 per cent and expected to move higher from Q2 FY13, RBI has a rather limited window of opportunity to support growth. This might have prompted the front-loading of interest-rate cuts.
On the face of it, this action indicates a shift in stance in favour of propping up growth. However, to control inflationary expectations there was a need to balance the policy through an appropriately hawkish guidance so that this 50bps rate cut does not dilute the credibility of the RBI’s anti-inflationary stance. There are too many moving parts to the inflation outlook and it is likely that price pressures will come back in the latter part of the year. Even the rather optimistic RBI forecast of 6.5 per cent inflation by March end is higher than the comfort level of the central bank.
We still expect another 25bps of rate cut from RBI but acknowledge that quantum of further rate cuts are becoming increasingly data dependent. Also, the extent of fiscal consolidation and response of investment activity to the rate cuts will be critically watched. If government delivers on its fiscal promise and the sentiment swing in the private sector brightens the investment outlook, then RBI will have more leeway to consider rate cuts. Let us not forget that expansionary monetary policy should only push us towards the potential growth rate but unless we drive the production frontier higher by suitable supply side reforms, it might be difficult to get back to pre-crisis growth.
Samiran Chakraborty, Regional head (research), Standard Chartered Bank, India