RBI eases while maintaining caution: Gunit Chadha

RBI’s 50-bp rate cut, which comes after three years, surprised us positively, as we were expecting a 25-bp cut in the April monetary policy meeting. A status quo in CRR rate is, however, in line with our expectations, given the recent improvement in money market liquidity conditions. RBI’s move to increase the borrowing limit of commercial banks under the marginal standing facility from one to two per cent of NDTL is also encouraging, as it should help provide a bigger cushion to the banking system in the event of any severe liquidity shortage.

Despite a discernible slowdown in growth momentum, particularly in the last quarter of 2011 (real GDP growth had fallen to 6.1 per cent y-o-y), the central bank was unable to cut rates through Jan-March 2012, due to lingering inflation risks. RBI’s decision to finally cut policy rates was driven by the following factors, in our view: i) core inflation softening to 4.7 per cent, almost close to RBI’s comfort range of 4-4.5 per cent; ii) steady deceleration in inflation momentum to below 5 per cent; iii) real interest rate turning positive after a span of two years and, iv) persisting weak growth momentum.

But even after cutting rates by 50 bps, we do not see RBI being too comfortable with the inflation outlook. It sees various potential upside risks to inflation going forward, emanating from i) uncertain global oil price trend; ii) possible fiscal slippages; iii) re-emergence of double-digit food inflation especially led by protein-rich items; and iv) eventual increase in domestic fuel prices. With such inflation risks persisting, the RBI understandably, has stayed away from giving any clear guidance related to further rate cuts going forward.

Given our expectations of growth and inflation for FY12/13 (DB’s forecast for real GDP growth is 7.5 per cent and end-March 2013 WPI inflation forecast is 6.8 per cent), we agree with the central bank’s guidance that there is limited scope for further reduction in rates.

But we do not think that on Tuesday’s rate cut was the last rate cut in this cycle. We expect RBI to entertain another 50bps of rate cut through 2012 (with the first 25bps rate cut likely in June) conditional on some progress related to fiscal consolidation and inflation remaining anchored below 7% on an average basis. However, if neither of the conditions are fulfilled, then the RBI could possibly delay the rate cuts to as late as the last quarter of 2012, in our view.

Gunit Chadha
Chief Executive Officer, Deutsche Bank, India