The Reserve Bank of India (RBI) has finally bitten the bullet and cut the repo rate by 50 basis points (bps). While the broader market was expecting a 25-bps cut, the central bank has been aggressive and front-loaded the rate cuts. Though the market has been taken by surprise by the aggressive cut, economists believe RBI has taken cognisance of the fact that this is no time for baby steps. Explains Sonal Varma of Nomura: “Though we were building in a 25-bps cut, it’s clear the central bank wants to send a signal, as the corporate sentiment is very weak.” Also, smaller cuts would have meant a longer transmission time.
What does this mean? From a macroeconomic perspective, this is important as RBI’s guidance implies that focus has shifted to growth. Explains Rohini Malkani of Citi, “While acknowledging that the ‘economy is operating below its post-crisis trend’, RBI expects growth to revert to its post-crisis trend and has, thus, guided FY13 GDP at 7.3 per cent against 6.9 per cent in FY12.”
Given that trend growth or non-inflationary rate of growth has fallen from the pre-crisis peak of 8.5 per cent to below seven per cent on supply-side issues, RBI has seen merit in supporting growth. Also, the moderation in inflation to under seven per cent has come in line with its projections and the upside risks to this would make further cuts a trifle difficult.
Though the 50-bps cut is twice of market expectations, it is not likely to be inflationary. Given that the growth trend is below even the post-Lehman crisis levels, all the cut would do is push it close to post-crisis levels. Though the April reading would reflect some spike in inflation due to tax measures, the risk to inflation is lower as commodity prices are expected to be largely benign in FY13.
In FY12, non-fuel commodity inflation rose 40 per cent year-on-year but is down to zero this year. Going forward, food prices may rise, but this would have little impact on core inflation. Sanjay Mathur of RBS, therefore, believes while RBI has not provided an average inflation forecast for FY13, it has provided a point estimate of 6.5 per cent for March 2013, with a commitment to contain inflation expectations within 4-4.5 per cent. "Nonetheless, the scope for deviation is assessed to be greater for inflation than growth,” he adds. If at all there is a trade-off between growth and inflation, it seems growth will score. This is possibly the reason economists are building in another 25-50 bps cut by the end of the financial year.