As expected, the Reserve Bank of India (RBI) has cut the repo rate by 25 basis points (bps), supporting government's reforms and fiscal measures to revive growth. The underlying factors have been improvement in trade deficit, drop in core inflation, achievement of 5.2 per cent fiscal deficit and, most important, slowing growth.
There has been a cautious note by the RBI governor, sobering expectations of significant further cuts. With WPI (wholesale price index) and CPI (consumer price index) still stubborn (and added pressure from fuel deregulation), we do not expect more than 50 bps additional repo cuts for the rest of the year. Notwithstanding the notable decline in core inflation, RBI remains worried about the increasing wedge between the wholesale and consumer price inflation.
The key culprit, food inflation, is likely to remain elevated and faces upside risks from populist increase in MSP (minimum support price). The central bank expects headline inflation to be around current levels during 2013-14, due to sectoral demand-supply imbalances and ongoing upward revision in administered prices.
On the growth side, the central bank is perturbed by the sharp deceleration in services sector growth, which has been the mainstay of overall growth. RBI reiterated its view that though lower rates are necessary, it might not be sufficient to revive growth in the absence of resolution of supply bottlenecks and improving governance around project implementation.
This puts the responsibility of growth revival categorically on the government. While the rate cuts have positive impact on the sentiment, immediate monetary transmission on account of the repo cut is difficult due to liquidity tightness in the system.
Even in January, when repo and CRR (cash reserve ratio) were cut 25 bps each, private banks did not pass on the benefit. The State Bank of India passed on five bps but other PSUs passed on 25-30 bps. At this point, with deficit in the LAF (liquidity adjustment facility) window of over Rs 1 lakh crore, there is a structural issue. Deposit rates have increased in the past few months and so have CP (commercial paper) and CD (certificate of deposit) rates, despite repo cut. Liquidity situation will significantly need to improve before RBI rate cuts are passed on to bank borrower. OMOs (open market operations) and possibly more CRR cuts might be in the offing in the annual review meet.
Nirmal Jain
Chairman, India Infoline
