Will RBI Nudge Government By Rate Cut On Oct 4 When MPC Meet?

With all the noise that BJP led government is facing on economy slowing down, jobless growth, falling jobs and one off measures such as demonetization and GST, RBI is going to announce on 4^th October if they would go ahead with a cut in interest rates for banks.

It is also expected that RBI might revise down the GDP growth forecast for FY 2017-18.

The current REPO rate is 6% and reverse REPO at 5.75% which are at seven-year low.

Monetary Policy Committee (MPC) Review

MPC is a committee that is tasked to fixing the benchmark interest rates, namely, REPO & reverse REPO, that banks are either paid or they pay to RBI as part of lending and borrowing. MPC is headed by RBI Governor, in this case, Mr. Urjit Patel.

Through this committee RBI tries to control inflation within the defined targets through credit flow in the economy and considering the fiscal policy of the government.

RBI’s MPC in the last meeting that happened in August despite of a neutral view on the policy went ahead with a rate cut of 25 basis points (0.25%) in REPO rate and at the same time had lowered the growth rate from 7.4% to 7.3% for FY 2017-18.

Why RBI might do a rate cut considering the State of Economy?

Indian economy is going through a slowdown that started in second quarter of 2017 Fiscal and followed by to major decisions of the central government, Demonetization and implementation of GST has only added to the problem, if not permanently, at least temporarily.

GDP growth rate for Q1 FY 2017-18 came down to 5.7% from 6.1% in Q4 FY 2016-17 and is believed to be not yet the bottoming out. India is no more the fastest growing economy since last two quarters and 5.7% growth is the worst since the time Narendra Modi led BJP government has come to power.

The only hope that market has is the post GST normalization that will help bring back things to normal and a seasonally good quarter ahead.

On the inflation side, Consumer Price Inflation (CPI) has increased to 3.4% for August month which was 2.6% in July. However, RBI has set a medium target of 2-4% and is comfortable if it’s under 4%.

Index of Industrial Production (IIP) also saw weakening in Q2 FY 2017-18 which normally is the best period for Indian economy as the festival season starts to pick up the demand and consumerization. IIP came down to 0.2% in August from 1.2% in July. However, this also has an impact due to GST glitches.

Credit growth in the economy has fallen and further banks contribution to the credit growth has come down drastically which means that businesses are taking less credit for expanding and their source for such funds are not banks.

Why RBI would stick to current rates and only look for it the next year?

Fiscal deficit consolidation that government has been sticking to now looks difficult to achieve as the government faces more and more heat on account of economic slowdown and GST issues from all corners.

The government is already planning to provide stimulus packages to various industries to revive them and at the same time is looking at options to increase its spending to bring economic growth.

Stimulus packages would mean that government will not able to meet the fiscal deficit target for FY 2017-18 at 3.2% and inflation would also jump beyond the levels RBI is comfortable with.

However, government is also looking at ways to raise money without affecting the fiscal deficit through higher borrowing, disinvestments, infrastructure bonds and recapitalizing the banks through selling stake or issue of bonds.

On the rupee depreciation, a rate cut would seriously impact rupee since the rest of the economies are increasing rates and if RBI cuts the rate, the overall returns would reduce leading to a large sell off by Foreign Institutional Investors (FIIs) thereby depreciating the rupee to record new levels.

Will a rate cut really help the economy?

The traditional theory or belief is that when the economy is not doing well and a slowdown is picking up, rate cut is the only option that would reduce the pace of slowdown.

However, looking at the recent history, RBI has decreased the interest rates by almost 200 basis points since 2015 and banks have not passed the same benefit to the consumers thanks to their asset quality and high provisioning requirement as guided by RBI.

What do Economists and analysts believe should happen?

A poll by Economic Times of 60 economists suggest that RBI would keep the rates as-is with a downgrade on GDP growth for FY 2017-2018. Inflation been at 3.6% would not excite RBI to cut the rates as they are comfortable with medium term target of 2-4%.

At the same time, two third of the forecasters believe that inflation would soon cross the RBI’s target of 4% and that RBI would not cut the rates until April 2019.