Will RBI respond to Government’s bold steps with 25 bps rate cut?
The expectation post headline WPI inflation print above 7.5% was for RBI to stay focussed on elevated headline inflation and maintain status-quo in mid-term monetary policy review. But then, Government acted in a hurry by delivering price hike in diesel and removal of subsidy in LPG beyond 6 cylinders per year. This was also followed by other policy measures relating to FDI. Government has acted to address issues relating to fiscal consolidation and policy paralysis to push the ball into RBI’s Court. Is this good enough for RBI to act? The answer to this is just round the corner.
RBI is facing strong headwinds and rough weather in its efforts to get headline inflation into its comfort level of 6% from current level of over 7.5%. The immediate risk is of further upward pressure into 8% driven by impact of diesel price hike, bullish commodity prices, not-so-good monsoon, and supply side concerns. There seems to be no linkage between growth and inflation. The downtrend in growth momentum into 5% should have eased pressure on inflation. When it has not, RBI may stay hesitant to take growth supportive stance which could hurt inflation. RBI has already taken strong position that it would not get into growth supportive stance till inflationary expectations turn favourable. Unfortunately, it is not at this stage.
RBI may also be compelled to act to maintain the positive (and bullish) sentiments post QE3 and Government’s measures. The liquidity position is now comfortable. It will be now easy for RBI to maintain deficit system liquidity below 1% NDTL through OMO bond purchases (in the Money market) and USD purchases (in the FX market), thus ruling out CRR/SLR cut. RBI may not opt for shift of system liquidity from deficit to surplus, in which case operative policy rate (and overnight call money rate) will fall sharply from 8% to 7% (without rate cut). This move will spur demand and would hurt inflation. The next option for RBI is to deliver 25 bps cut in Repo rate to retain current bullish market sentiment and as reward for bold steps from the Government despite stiff opposition within and outside UPA. It is a 50:50 probability between status-quo and 25 bps cut in Repo rate. If forced to choose one, MARKET PULSE will bet small money on 25 bps cut in Repo rate. It is considered good to retain Reverse Repo rate unchanged at 7% as signal to retain its priority on inflation.
Moses Harding
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