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RBI raises rate cut hopes

Source : BUSINESS_STANDARD
Last Updated: Mon, Jan 28, 2013 20:11 hrs

 

With inflation falling to levels lower than expected by the Reserve Bank of India (RBI) and economic growth expected to slow further this year, the central bank on Monday said if moderation in inflation continued, it would focus on reviving growth.

 

In the monetary and macroeconomic development report released on Monday, a day ahead of RBI’s third quarter review of monetary policy, the central bank said, “The moderation in inflation during the third quarter of 2012-13 was faster than expected during the second quarter review. If inflation continues to trend down, the monetary policy could increasingly shift focus and respond to growth moderation.” However, RBI added its policy stance would also depend on various macroeconomic and financial parameters.

While the Street expects RBI to cut rates tomorrow, it doesn’t expect the cut to be more than 25 basis points. This is because the central bank said though core inflation had declined, headline inflation was still above its comfort zone. “Given the preponderance of non-monetary factors behind the current slowdown in an environment where risks from high inflation, current account and fiscal deficits still remain, the scope for supportive monetary policy action is constrained,” RBI said. But, it said as reform announcements by the government were executed, monetary policy would increasingly focus on growth revival.

We maintain our view of a 25-bp repo rate cut and no change in the cash reserve ratio tomorrow, in line with consensus. Monday's macro report suggests that the forward guidance will also likely be hawkish with the RBI highlighting the downward rigidity in inflation and the twin deficits as limiting the scope for aggressive policy easing, and therefore maintaining its calibrated stance, said economists Sonal Verma and Aman Mohunta of Nomura Securities adding they now expect 50 bp in repo rate cut in 2013.

While the central bank lauded the government’s commitment to restricting its fiscal deficit to the targeted amount, current account deficit (CAD) has emerged as a major concern for the regulator. “At the present juncture, the widening CAD has become a major constraint on easing monetary policy. Even if inflation recedes further, the wide CAD may slow the pace and extent to which the monetary policy can be eased,” RBI said.

It added with CAD expected to exceed four per cent of gross domestic product (GDP) for the second consecutive year in 2012-13, prudence was necessary while stimulating aggregate demand. “Given India’s low trade elasticities, especially at this point when world demand is low, there is little alternative but to use expenditure-reducing policies in addition to expenditure-switching policies to reduce CAD to a more sustainable level of about 2.5 per cent of GDP,” the report said.




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