In line with the policy actions taken last week by Government of India to support the economic growth momentum, the Reserve Bank cut the Cash Reserve Ratio (CRR) after a gap of six months by 25 basis points to 4.50 per cent of NDTL in an unexpected move.
In our view, the CRR cut is likely to result in a token reduction in lending rates, given the recent revisions in deposit rates and lending rates for certain products already undertaken by some banks.
GLOBAL FORCES
While the measures initiated by the Government have boosted sentiments, the impact on investment decisions and economic growth may take place with a lag.
In terms of the inflationary concerns, the improvement in monsoon rainfall and pickup in kharif sowing in recent weeks have eased concerns regarding the outlook for agricultural output and food inflation.
The increase in the price of diesel has reduced the magnitude of suppressed inflation in the economy to some extent, which is a positive sign.
Nevertheless, the first and second round impact of the diesel price hike is likely to push headline WPI inflation above 8 per cent in October 2012, from an average of 7.4 per cent in the first five months of FY13, which may harden inflationary expectations to an extent.
Moreover, the impact of the liquidity measures undertaken by the European Central Bank and the Federal Reserve on global commodity prices and the rupee exchange rate would have a significant bearing on the Indian inflation trajectory in the coming quarters.
MUTED EXPECTATIONS
Given the frontloading of the reduction in the repo rate by 50 bps by the RBI in April 2012 and the likely pick-up in WPI inflation in the immediate term, the RBI may refrain from cutting the policy rate in its second quarter policy review in October 2012.
Going forward, the shift in growth-inflation dynamics would influence the timing of reduction in the policy rate.
We continue to expect further cuts in the repo rate to be limited to 25-50 bps in the remainder of the financial year.
(The author is MD&CEO, ICRA Ltd.)