'Rate cut' or 'No rate cut': Factors surrounding this monetary policy

The Reserve Bank of India (RBI) will announce its fourth bi-monthly monetary policy on Tuesday at 2.45 pm. It willl be the first policy announcement by Urjit Patel as the RBI governor. It will also be the first where the decision will be taken by a six-member team of the newly-constituted monetary policy committee (MPC).

The decisions of this policy will be evolving around consumer inflation, wholesale inflation, bank deposits, and their credit growth, exchange rate and G-Sec yields (overnment securities).

Inflation:

Consumer Price Index (CPI) inflation relaxed in August 2016, to 5.05% breaking its four-month rising streak. This development in August also fanned hopes of being on track to achieve the government-set target of 4% inflation over the next five years.

source: tradingeconomics.com

Wholesale price index (WPI) inflation has seen a constant rise since FY17 started, moving out from the deflationary territory of FY16. WPI was at 2.29% in FY17 (April - August) compared with (-) 3.17% in FY16 (April - August).

Image source: tradingeconomics.com

Care Ratings said, "With favourable monsoons this year and increase in crop area leading to higher production for most crops, food inflation would tend to get moderated in coming months. However, increases in global oil prices following the recent OPEC production cuts could pressure fuel inflation in coming months.”

OPEC countries - a member of 14 nations, have decided to cut oil ouput to retrench the declining oil prices globally. 

"The production cut could lead to rise in oil prices at the international level. However, there still remains uncertainty regarding the timing and volume of production cut by the oil producers that raised questions about the execution and success of the same," said Care Ratings. 

Bank Deposit and Credit Growth:

Bank deposits stood at 5% as of September 2016, a marginal improvement from 4.4% seen in the same period of the previous year.

However, credit growth remained sluggish at 0.8% so far, compared to 2.3% seen a year ago in the same period, throwing light on the subdued investment scenario in the country.

As of August 2016, growth in bank credit was lower in all segments except services which increased by 1.2% (-1.6%). Credit growth to manufacturing sector declined further by 4.1% on top of -1.3% last year, while in case of personal loans, the growth was lower at 4.6% (5.7%) and agriculture 3.9% (5.5%), according to Care Ratings' data.

In terms of bank deposits, the agency stated that, growth in bank deposits has been higher notwithstanding the decline in interest rate on deposits from an average of 7.45% to 7.15% for deposits of above one year.

Government Securities:

Led by rising demand in safe haven assets – which was boosted by Britain's Brexit decision and favorable domestic liquidity situation at the system level (owing to the liquidity infusion by the RBI of about Rs 1,000 bn through OMO), the 10 year G-sec yield have witnessed significant decline in past few months.

So far, the G-sec yields have declined by 65 basis points.

On September 2, 2016, the central bank issued new benchmark rate of 6.97% for G-sec, which are considerably much lower from previous G-secs which has rates between 7-8%.

source: tradingeconomics.com

Care Rating said,The decline in the G-Sec is often seen as an indication for rate cuts. However, in the prevailing Indian context it is also driven by the liquidity in the system.”

Exchange Rate :

Care Ratings said,"One of the objectives of the monetary policy is to curtail the volatility in the exchange rate. Although, the rupee is under pressure with the redemption of the Foreign Currency Non-Resident (FCNR) deposit due from September’16 onwards, the sustained foreign inflow and the RBI’s proactive measures to tackle the expected foreign currency to emerge with the FCNR redemption have helped curtail the down pressure on the rupee."

Since June 2016, the Indian rupee has appreciated by 2%. 

'Rate Cut or No Rate Cut'

Kavita Chacko, economist of Care Ratings said,"Based on these considerations we feel that there is 70% chance of no change in rates as the RBI may like to get more clarity on the above issues and a couple of more data points would help to be certain."

Chacko added," The 30% probability of a rate cut of 25 bps will be driven by market assuage measures against the backdrop of the surgical trikes conducted last week with the economic justification of the start of the busy season also playing its part."

"Assuming no change this time, we do expect 25bps cut in December provided these conditions hold."

India Ratings too had the same view on the monetary policy. It feels a rate cut of 25 basis points in December can be expected, they said.