Global deflationary trend to drive rate cuts

Central bank does 50 bps rate cut to boost demand as growth and reforms falter

Economic recovery continues to be weak, if the Reserve Bank of India (RBI)'s surprise move to cut the repo rate by 50 basis points (bps) is anything to go by. To spur demand, the central bank slashed the repo rate by 50 bps to 6.75 per cent. With this, RBI has cut 125 bps so far this year. With inflation not showing any sign of accelerating, and the US Federal Reserve delaying a rate increase, RBI has chosen to use the window of opportunity so that domestic demand gets a boost. With underlying economic activity remaining weak, RBI marginally cut FY16's projected growth to 7.4 per cent from 7.6 per cent. CRISIL Research says the onus is now on the government to remove hurdles to transmission while following a wise financial path.

With commodity prices hitting new lows and global recovery getting further delayed, RBI has decided to give the economy a boost in the form of a rate cut. Clearly, it has cut sharply to kick-start demand and investments. Motilal Oswal, chairman and managing director of Motilal Oswal Financial Services, believes RBI has sought to give a boost to investment.

RBI has also marked down its near-term inflation projection for January 2016 to 5.8 per cent from six per cent. But, economists believe inflation expectations are still high and backward-looking. By end-FY17, RBI expects inflation to come down to five per cent. Given that RBI has done the rate cut, Sonal Varma, chief India economist at Nomura, expects the bank to remain on a prolonged hold through end-2016. The underlying inflation trend is expected to stabilise at five to 5.5 per cent, if disinflation does not persist further. (Disinflation is a reduction in the rate of inflation.)

Economic recovery continues to be fragile in large parts of the developed world and the sharp fall in commodity prices has hit growth of resource-rich countries. Emerging markets such as India are not unscathed by these developments. Deflation (negative inflation) continues to be a big risk to global growth and if it persists, RBI might have to act. Abheek Barua, chief economist at HDFC Bank, says: "Given the RBI governor's guidance and the fact that he views the more aggressive 50-bp slash as a front-loading of policy easing, it appears the cut could be the last for the current financial year." But, RBI said it would be willing to ease the rate further, if weak global growth were to continue.