What to expect from RBI on 18th December 2012?

Choice is between 25 bps cut in CRR or policy rates

The stake holders await RBI’s action on its quarter review of monetary policy with feel-good sentiment and confidence on the way forward. There is plenty of action on policy reforms from the Government since September 2012 despite its minority status in the Parliament. There is strong commitment on fiscal consolidation to contain FY13 fiscal deficit at 5.3%. The Government has succeeded in getting political consensus on its reforms agenda and now keenly awaits RBI to walk in the same direction by starting the rate reversal cycle. The other stake holders of the economy are keen to see the political system, the Government and RBI to walk together to get the economy back on its feet. The macroeconomic fundamentals are weak and it would need strong growth-supportive monetary environment for quick revival. Given these factors in play, RBI has reasons to deliver rate cut now rather than delaying it to January-March 2013 when signals provide greater confidence on downtrend in inflation and strong headwinds to growth momentum.

The recent economic data on IIP and WPI caught the economists/analysts on the wrong foot. The October IIP numbers are strongly up and November headline WPI inflation firmly down against expectations. It was pleasant surprise and sent awe feeling for many. The concerns for RBI will be from upward revision in September headline WPI inflation above 8%, sticky headline CPI close to 10% and elevated food price inflation. However, expectation and trend in headline WPI inflation is firmly down while confidence on turnaround in growth momentum is sticky. RBI may need to shift its bias from inflation to growth this time but may find it tough to defend rate cut delivery against its firm stance of caution against elevated inflation and low real interest rates.  While it will be easy and straight-forward for RBI to deliver 25 bps CRR cut to cover advance tax outflows and maintain dovish stance on the way forward, RBI may also consider the other option of delivering 25 bps rate cut with caution on inflation.

There are four options before RBI: (a) unchanged stance by addressing liquidity concerns through OMO bond purchases and dollar purchases and await confirmation on reversal in headline inflation before shifting into rate cut mode; (b) 25 bps CRR cut maintaining the same indecisive and cautious stance; (c) 25 bps rate cut to be seen as being with the Government on revival of Indian economy and (d) 25 bps cut in CRR and policy rates as reward for the aggressive stance of the Government in addressing fiscal consolidation and its hyper-action on policy reforms. There will be feeling of shock on unchanged stance and awe sensation on delivery of 25 bps cut both in CRR and policy rates. The choice therefore is between 25 bps cut either in CRR or policy rates and it is tough to choose between the two. The Governor has always chosen to surprise the market on policy day by delivering the unexpected; stake holders are unanimous in expectation of shift into rate cut mode in January-March 2013; so delivery of 25 bps cut in policy rates will be a surprise, pleasant one for sure! The bullish undertone of the Interest rate market will be maintained irrespective of 25 bps cut in CRR or policy rates. 10Y Bond is expected to get into consolidation mode at 8.0-8.10%; at higher end on CRR cut and at lower end on rate cut.

Moses Harding