A sharp reduction in repo rate has come sooner than desired, given the upside risks to inflation, according to Crisil Research.
The lowering of interest rates may sound like good news in the scenario of fledgling growth, but by itself it may not be enough to stimulate investment and GDP growth. The investment slowdown can largely be attributed to policy bottlenecks rather than high interest rates.
Hence, for growth to revive, the investment climate supported by appropriate policy reforms will have to improve.
The economy is now wedged between sub-seven per cent growth and seven per cent headline inflation. In addition, six consecutive years of high inflation has heightened fears that the normal level of inflation has risen beyond the RBI’s stated tolerance limit.
If inflationary pressures resurface, the RBI will be left with little room to cut the rates further. In that case, yesterday’s rate cut could turn out to be the last one in this year. Letting down the guard on inflation at this point could prove to be a risky proposition, Crisil Research said.
The reversal towards an easy monetary policy stance, coupled with already loose fiscal policy, does not bode well for controlling inflation on a durable basis.
Fitch Ratings
The market was expecting a maximum 25 basis points cut in repo rate after the RBI’s macroeconomic report only the previous day, says Dr Devendra Kumar Pant, Director, Fitch Ratings.
Core inflation measured by non-food manufactured products in March 2012 declined to 4.7 per cent, although higher than the RBI’s comfort level of four per cent. Headline inflation is still high, and growth has slowed down considerably to 6.1 per cent in October-December 2012.
Having controlled inflation to a certain extent, the priority has been shifted to giving boost to economic growth. The 50 bps cut in repo rate is a step in this direction, Mr Pant said.
The central bank has said that the scope for future cut is limited; this would largely depend on how inflation and growth scenario pans out in 2012-13.
Standard Chartered Bank
The larger-than-expected repo rate cut was probably driven by two factors.
First, the RBI needs to balance growth and inflation requirements. Given the positive output gap, growth clearly needs supportive polices.
However, with inflation still hovering at seven per cent and expected to move higher in the next few months, the RBI has a limited window of opportunity to support growth.
Indeed, the RBI is non-committal on further easing, as it sees upside risks to its inflation forecast of 6.5 per cent for March 2013.
Secondly, a 50 bps repo rate cut is likely to ensure better transmission of monetary policy, which is necessary to nurture a growth revival.
“With this statement, we highlight a risk to our call of further rate cuts by the RBI. We had expected 75 bps of repo rate reductions in 2012-13,” a Standard Chartered team said.
On the face of it, the repo rate cut and the resulting stimulus to growth appear positive for the Indian rupee. However, the cautious stance of the RBI towards future rate cuts is likely to dampen the impact.