RBI may not slash repo rate post Fed move

The emergency cut in the overnight rate by the US Federal Reserve has triggered widespread expectations of an easing of monetary policy in India.

However, doubts still persist in some quarter as to whether the Reserve Bank of India (RBI) would actually cut the repo rate.

RBI will undertake a quarterly review of its monetary policy on January 29, when the threat from oil and food prices to inflationary expectations are likely to hold sway. Inflation would move closer to 5 per cent from a little less than 4 per cent at present with an increase in domestic retail fuel prices looming.

"We don't think RBI wants to cut rates in its monetary policy at all. Real lending rates at 7.75 per cent are just about neutral at our estimated 8 per cent potential real GDP growth rate," said Indranil Sen Gupta, economist at DSP Merrill Lynch, in a note released today.

While stating that RBI is expected to reluctantly cut its repo rate by 25 basis points to 7.50 per cent, forced likely by the imperative of capping the rupee by neutralising a rising differential with the US money markets," Indranil said. "Given the fluid situation, we will view matters again on Friday (tomorrow)."

"Real interest rates in India are on the higher side. Despite some global risk on energy and food prices, with inflation and credit growth under control, there is a strong base case for reduction in interest rates. We could see a 25 basis point reduction in both bank rate and repo rate. It's important to note that the high cost of capital is affecting the infrastructure and manufacturing sectors," said Rana Kapoor, managing director and chief executive officer, Yes Bank.

The expected rise in capital inflows with the lowering of rates in the US would add to inflationary pressures, as the flows ultimately lead to an increase in money supply. RBI absorbs the capital flows but, in the process, infuses unintended rupee liquidity.

"We expect RBI to try to contain the inflation risks of rising M3 (money supply). Aggressive MSS auctions and even CRR hikes are likely to resume after credit demand eases in March. We feel RBI is likely to delay cutting the LAF (liquidity adjustment facility) reverse repo rate till April. Seasonal credit demand typically pushes money markets to borrowing from the repo window than depositing at the reverse repo counter," said Indranil.

A record $56 billion of forex has flowed since March 2007, which far exceeds the $18 billion needed to fund the expected 8.8 per cent real GDP growth in 2007-08, according to Indranil.