Seven out of 10 bank economists expect RBI to cut its repo rate by 25 basis points to 6% when the central bank’s monetary policy committee meets on 7-8 February for the bimonthly credit policy. The other three expect the repo rate to remain unchanged. A basis point is one-hundredth of a percentage point.
RBI has already surprised the market twice: in October 2016 governor Urjit Patel announced a 25 basis point reduction when the market was widely expecting a status quo. And in December, the banking regulator kept interest rates unchanged against a popular expectation of a rate cut.
“It could be a close call this time as the inflation situation looks good and the government has made it clear that it wants to push growth. But the benefit due to deposits that came in during the 50 days of demonetisation has already helped the interest rates in the markets to come down. We have factored in a 25bps rate cut,” said Soumya Kanti Ghosh, chief economic adviser, State Bank of India.
Retail inflation decelerated to a two-year low of 3.41% in December from 3.63% the previous month as vegetable prices continued to fall.
RBI is aiming to keep retail inflation under 5% in the fourth quarter and 4% within a band of 2 percentage points on either side in the medium term.
Announcing the last monetary policy on 7 December, the central bank said that a drop in vegetable prices might bring down overall retail inflation. Any inflexibility in the downward movement of inflation components other than food and fuel, however, may cause some resistance in the future softening of the headline inflation number.
Following the announcement of demonetisation on 8 November, most banks saw a surge in deposits held in savings account, giving a boost to their current account, savings account (CASA) ratio and reducing their cost of funds. Most banks pay only 4% interest on savings bank accounts.
According to Rajib Sahoo, chief economist at state-run Canara Bank, interest rates may drop since the US Federal Reserve has hit the pause button on interest rates, while inflation has been softening.
“The latest PMI (purchasing managers’ index) numbers for services was 48.7 in January as against 46.8 in December and PMI manufacturing has slightly improved to 50.4 in January from 49.6 in December, but is still very modest,” Sahoo said.
The low PMI numbers and slow credit growth indicate that India’s private sector has been struggling with growth. In this situation, a lower interest rate may actually spur growth.
However, some specialists say that given the way banks have cut interest rates in the last few weeks, a rate reduction by RBI may not be necessary. In the last month alone, several banks have reduced their marginal cost-based lending rates by up to 90bps, ushering in a low interest rate regime for new borrowers across the board. This was due to the low-cost deposits coming in after demonetisation.
Apart from this, the regulator may want to wait for some more macroeconomic data.
“Given that economic conditions still remain very uncertain, it is likely that the central bank will defer a decision on a rate cut till April. Although the budget was conservative, global risks are still evolving, commodity prices remain high, core inflation remains sticky, and the first forecasts of monsoon will be released among other things,” said Saugata Bhattacharya, chief economist, Axis Bank Ltd.