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Despite both headline and retail inflation increased in February, the fall in non-food manufacturing or the core inflation may provide the central bank scope for reducing interest rate for the second consecutive time, this policy review.
While reducing interest rate by 25 bps to 7.75% in January policy, the central bank had stated further easing of interest rate will depend on the inflation trajectory. After the third quarter review, the government has released WPI inflation figures for January and February.
Though January inflation rose by 6.62% -- at the slowest pace in three year – but in February, WPI inflation rose by 6.84% primarily due to higher fuel costs. Consumer price index inflation or retail inflation accelerated by 10.91% in February as compared to 10.79% increase in January.
The comforting factor however is, core inflation – a yardstick by which RBI measures demand side pressures – further slowed to 3.8% from 4.1% in January.
Bond yields, which initially went up following the announcement of higher WPI inflation number, but dropped 5 bps as core inflation moderated. Market participants, though not expect any sharp rate cut by RBI next Tuesday – when the central bank will meet for mid quarter policy review – but are betting for a 25 bps rate reduction.
Another important event post the last policy review, that will space RBI’s decision making, is the Union budget where finance minister reinforced the centre’s commitment for fiscal consolidation. The fiscal deficit for the next financial year is pegged at 4.8% as compared to 5.2% in 2012-13.
Acknowledging finance minister’s effort to the RBI governor Subbarao said on Wednesday that budget has firmly embraced fiscal responsibility by restraining the fiscal deficit next year.
“There has been some very welcome, although much delayed, action on correcting both the CAD and the fiscal deficit over the last six months. The Government has raised customs duty on gold imports in an effort to restrain gold imports. More notably, the recent budget has firmly embraced fiscal responsibility by restraining the fiscal deficit next year consistent with the road map recommended by the Kelkar Committee,” Subbarao said in a speech at the London School of Economics.
While market is hoping for rate cut but chances of a reduction in the cash reserve ratio – which was also cut in January – is weak. CRR – the proportion of deposits banks need to keep as cash with RBI – is already at historic low, at 4%. RBI had reduced CRR by 200 bps since January 2012 to ease liquidity conditions.
Liquidity in the banking system, which is still above the comfort zone of RBI, but expected to ease in April – as demand for cash is generally lower in the beginning of a new financial year.
Today, banks have borrowed Rs 92,500 crore from the repo facility of RBI, which is higher than the central bank’s comfort zone of +/- 1% of bank’s net demand and time liabilities.
