Lending rate cuts key to recovery: Indranil Sengupta

Monetary tightening has become counter-productive - hurting growth rather than taming inflation

We continue to expect the Reserve Bank of India (RBI) to try to revive growth through monetary easing, but talk in a hawkish manner to contain inflation expectations. After all, India is a rare economy in which lending rates are still stuck at their 2008 peak levels. Growth would not recover till lending rates come down. Though we fancy ourselves as hawks, we cannot deny that monetary tightening has become counter-productive - it is hurting growth rather than taming inflation, which is largely imported.

In fact, India's inflation, at 1.6 times the growth, is no worse than Brazil's 4.1 times or Russia's 2.6 times. We do appreciate that RBI would have to maintain its hawkish talk, as inflation would likely rebound after September due to hikes in diesel prices and power tariffs. Still, it is only being prudent in front-loading rate cuts to arrest the slowdown. We expect another 25-basis-point cut on June 17. Importantly, RBI rate cuts wouldn't translate into lending rate cuts till bank liquidity improves. We, therefore, expect it to inject Rs 1.6 lakh crore through open market operations, in addition to cutting the cash reserve ratio by 50 basis points after October.

We hope RBI starts buying forex. After all, the import cover (i.e., months of imports fundable by forex reserves) has halved to seven months - last seen in 1996 - in the past four years.

At the same time, we do not worry as much about the high current account deficit, as a good part of this (about 1.5 per cent of gross domestic product) is really statistical. This reflects (1) a shift of non-resident Indian (NRI) savings of, say, $10 billion to NRI deposits (in capital accounts) from remittances (in current accounts) after NRI deposit rate hikes, as well as (2) overestimation of oil exports by the trade ministry, relative to the oil ministry, by about $15 billion.

Indranil Sengupta
India Economist, Bank of America Merrill Lynch