RBI in 'wait and watch' mode on inflation, don't expect a rate cut now

Will RBI lower rates in the year? The answer is definitely yes, though timing may be uncertain.

The RBI policy has been on expected lines with no change being reckoned on the policy rates. However, the cut in SLR comes at a time when banks have been flushed with excess liquidity in the region of Rs 3.5-4 lakh crore in the last 2 months. Hence, it is not so much as providing them with a window to get more liquidity as much as helping them with their LCR requirements as it takes on the target of 100% by 2019.

Now credit policy has been linked inexorably with CPI inflation which has been moving downwards. Here the RBI’s view is interesting as mention has been made of two different forces making it cautious on the same. First is that the factors that have driven inflation down i.e. fuel and pulses have been straightened which will stop the downward movement in prices. The statistical base effect also has played its role here. 

The second is higher demand pull inflation which would result from both higher wages and fiscal deficit. The former gets linked with the Pay Commission impact. The latter is linked with the loan waivers being spoken of from both the central and state governments. Yet the RBI forecast is a range of 2-3.5% for the first half and 3.5-4.5% for the second half. Hence, it is clear that the RBI is in a ‘wait and watch’ position on inflation and hence would wait for some more time before it takes action.

Interestingly, the RBI has lowered its GVA forecast to 7.3% for FY18 as CSO released its revised forecasts for FY17 where GDP was expected to be 7.1%. Given that banks have lowered their interest rates on their own volition, there is more space provided to the RBI to wait for some more time. Quite appropriately the RBI believes that it will take time for the investment to pick up given the twin problems of high leverage on corporate balance sheets and high NPAs on the books of banks. It is apparent that the focus going ahead will be on addressing these issues.

Two issues on the regulation front have been touched upon in the policy which would be positive for the relative segments. The first pertained to masala bonds where the norms for issuance are to be reviewed which are positive for companies that are raising such funds. The other pertains to the risk weight norms for some categories of home loans which will definitely help banks as there has been a tendency for them to lend more to this segment. 

Will the RBI lower rates in the year? The answer is definitely yes, though the timing may be uncertain. While inflation is low and trending downwards, the outlook on possible negatives that may be driving inflation forward will be critical in this context. Presently, if inflation remains benign – and there is no reason to think otherwise, a cut of 25 bps may be expected in the next half though it is more likely to be invoked in October when the busy season starts.  Madan Sabnavis is the chief economist at CARE Ratings.