The Reserve Bank of India’s 25 bps CRR cut is welcome and in line with our view to pull down lending rates.
This should enable lending rates coming off another 50 basis points by March to support recovery. Unless this happens, it would be difficult to forecast a growth rate of 5.6 per cent for FY-13, let alone the RBI’s 6.5 per cent forecast.
It is understandable that Governor Subbarao is reluctant to take chances with the RBI’s inflation-fighting credentials by cutting rates. After all, September inflation will pierce 8 per cent due to diesel and cooking gas price hikes. In any case, RBI rate cuts may not translate into lending rate cuts until bank liquidity improves.
ENOUGH OF TIGHTENING
We are happy that the RBI has re-affirmed that “…monetary policy also has an important role in supporting the growth revival...”. We think tightening is becoming counter-productive. While it cannot dent supply-led inflation from oil, rain and global liquidity shocks, it is hurting growth.
On our part, we expect the RBI to cut the CRR by 50 basis points on October 30 and cut policy rates by 75 basis points between December-March as inflation abates.
Needless to say, we are relieved that Delhi has finally taken steps to revive growth. At the same time, while ‘reforms’ like introducing FDI in multi-brand retail are boosting sentiment, their impact will be felt only in the medium-term. In the short run, the revival of growth will need softer rates.
INFLATION THREAT
Inflation is expected to peak at 8-8.5 per cent levels by December and come off to 7.3 per cent by March. First, the recent revival of rains should contain food inflation. Second, Operation Twist II is unlikely to have much of an inflationary impact on India, unless oil prices increase.
Most commodity markets face a reasonably favourable demand-supply balance globally. Third, the long pending electricity and administered oil price hikes have finally taken place. Finally, excessively tight M3 growth, running at 13.7 per cent, way below optimal 16-17 per cent levels, is constraining corporate pricing power by restraining demand.
(The author is India Economist at Bank of America Merrill Lynch.)