Over the last couple of years, the central bank has not cut rates significantly for a wide variety of reasons. Even though core inflation (non-food manufacturing inflation) started softening a while ago, the central bank held on to rates as both fiscal and current account deficits along with consumer price inflation stayed above its comfort zone. Now, it seems that the central bank will have little reason to justify its hawkish stance on rates.
For starters, the fall in crude oil and gold prices would have a positive impact on the current account deficit. Lower crude oil prices have the potential to shave off 50 basis points from the headline inflation print during the course of the year. Barclays expects the current account deficit to moderate to more than 3% of GDP over the next three years, which is much worse than the long term average of 1.5%.
Siddhartha Sanyal and Rahul Bajoria of Barclays Economics Research expect the commodity import bill to moderate in the near term, reflecting a relatively benign commodity price outlook, subdued domestic growth and likely softer inflation.
As global commodity prices continue to soften, economists are factoring in a lower than expected trajectory for headline inflation. Given that commodity prices are expected to stay soft through the year, economists are back to the drawing board working on inflation projections for the new fiscal. Last year, the Wholesale Price Index averaged at 7.4%, and the earlier projections expected it to average between six and seven%.
But now it seems that WPI print for FY14 could be below six%. Kotak’s chief economist Indranil Pan says: “Our revised inflation trajectory factors in the weakening momentum of WPI and current softer bias for commodities indicating an average of 5.5-6.0% for FY14 against 7.4% in FY2013.”
The markets have factored in a 50 basis point rate cut by June. While some believe it will happen in May others believe that the rate cut cycle will accelerate in the first half and there could be two cuts of 25 basis points each.
Bank of America Merrill Lynch expects RBI to cut 25 basis points on Friday, even as expects RBI to caution that room for further cuts would be limited. However, for effective transmission of the rate cuts, the central bank will have to ease liquidity conditions. In order to do this, the RBI will have to either cut cash reserve ratio by 25 basis points or commit to open market operations of Rs 1.4-1.6 lakh crore in FY14.