The credit policy this time is unique as for the first time there
is a 35 basis point (bps) cut in the repo rate. This is a kind of compromise
between the expected 25 bps cut and the more aggressive 50 bps which the market
wanted. This has not had an immediate impact on G-Sec yields with the 10-year
bond still at 6.31-6.33. The hope is that the transmission is faster to the
lending rates, which would soften and help industry grow.
The previous rate
cuts of 75 bps with accommodative stance have not quite worked to push
up investment, and hence it would be interesting to see if this fourth cut
changes the track. For sure some of the lending rates would come down, which
may benefit home buyers or companies with debt, but for investment to pick-up,
demand conditions need to change and turn positive. From a monetary standpoint,
this had to be done to support growth as inflation is largely under control
with favourable monsoon, crude prices and declining core inflation.
This entire chain of rate
cuts and GDP growth brings to the fore also the effectiveness of
monetary policy to stimulate growth. The process is long. First, the deposit
rates need to come down, marginal cost of lending rate (MCLR) have to come
down, bank spreads remain stable above MCLR, credit risk perception remain
positive and more importantly, demand has to be robust for funding. This is why
the link between interest rates and growth had been feeble. While models show
that it works with lags of four – six quarters, there could be several
developments that come in the way of growth.
The MPC has also brought down the projection of GDP growth of 6.9
per cent from 7 per cent, which is not significant but definitely does affect
sentiment as any number less than 7 per cent is interpreted as weakness
considering that growth was 6.8 per cent last year. Moreover, for the first
half, growth has been placed at 5.8-6.6 per cent. Growth in Q1 will be
particularly low and is expected at less than 6 per cent by the market given
the economic indicators available so far. There is, hence, a bet that the
economy accelerates to 7.3-7.5 per cent in H2, which will mean a very
favourable festival cum post-harvest season.
Going forward, it does look like that the MPC will be focusing
more on growth than inflation that has been taken to be within the comfort zone
for the entire year. The interesting conjecture that has to be made is whether
there will be more cuts in this situation.
Growth will be lower this year, and hence, with the number being
less than 6.6 per cent for H1, the question is will there be another rate cut
before the second half begins? This does appear to be the case and a repo rate
of 5.15 per cent in October looks more or less given and in case such weak tendencies
continue, the policy rate can go at less than 5 per cent too during the year.
The core sector data which came for June at 0.2 per cent was
dismal and indicates that industrial growth will be less than 1 per cent. This
has probably been kept in mind when taking a rate cut call this time as
inflation appears to be well within the 4 per cent band and presently is
hovering at just above 3 per cent with a favourable outlook. The rupee concerns
are still there and it looks more like that the external factors will drive the
rupee lower towards the Rs 70.5-71/$ mark in the coming months – though a lot
depends on how the FPI flows behave.
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