Despite inflation easing at the wholesale level and credit demand being slack, the Reserve Bank of India is unlikely to cut key interest rates as economists feel there is less scope for banks to pass on the rate cut benefit to borrowers.
According to Rupa Rege Nitsure, Chief Economist, Bank of Baroda, “Retail inflation and current account deficit (CAD) continue to remain high.
“Also, the RBI might feel that the rupee depreciation would have inflationary pressure. Hence, a rate cut by the RBI may not result in a cut in lending and deposit rates. So, we are not expecting a cut — either in repo, or cash reserve ratio (CRR) — in the first half of this fiscal.” Repo rate, the rate at which the RBI lends short-term funds to banks, is at 7.25 per cent. Since January, the central bank has cut repo rate by 75 basis points. However, this has not fully transmitted into reduction in base rate by banks.
On the other hand, liquidity management tool, CRR, has been reduced by 200 basis points since January 2012.
However, liquidity in June has improved, which leaves less room for further CRR cut. CRR is the proportion of total deposits that banks have to keep with the RBI. At present, CRR is at four per cent of the banks’ net demand and time liabilities. “CRR is already at historically low levels. Also, the liquidity has improved this month. Hence, we do not see any reason for a CRR cut,” Nitsure said.
Wholesale price index-based inflation eased to a 43-month low at 4.7 per cent in May. However, food inflation continues to remain high as it rose to 8.25 per cent in May.
CAD was also at a record high of 6.7 per cent in the October-December quarter. Though in the January-March quarter, it is expected to come down, the CAD is likely to be around 5 per cent. However, the rupee depreciation might widen the CAD for the April-June quarter in FY14. This may force the RBI to postpone the rate cut decision.
“The monsoon has been good so far. If this trend continues, then the RBI could assess the situation and a rate cut could follow later,” Nitsure said.
Vidya Mahambare, Principal Economist, Crisil, said, “If the rupee continues to fall further, diesel and manufacturing prices would be impacted negatively. Also with concerns on further withdrawal of quantitative easing by the US, capital inflows might be limited in June. Hence, we feel the RBI may pause for now.”
“We expect the RBI to cut 25-50 basis points by March 2014 and preferably in the first half,” she added.