India’s central bank unlikely to cut interest rates.
By R. Chandrasekaran
CHENNAI: The Reserve Bank of India is meeting on Monday to review the monetary policy and decide about the interest rates. There were some hopes of a cut in rates earlier, but the continued slide of Indian rupee has hurt such hopes despite the easing of headline inflation in May. However, optimists continue to believe of an impending rate cut.
Though there has been a clamor for reducing interest rates citing the easing of inflation in May to 4.7 percent from 4.89 percent, the retail inflation or food inflation, which moderated slightly, continues to remain a concern among the policymakers.
The headline inflation for May was 4.87 percent, better than analysts’ projections and the lowest in more than three years. From a revised inflation of 5.65 percent in March, inflation has come down by about 17 percent to 4.7 percent in May.
There is also no denying of the fact that the RBI is under pressure to announce rate cuts to stimulate growth as the economy reached a 10-year low. The index of industrial production (IIP) was also lower than expected in April, the first month of the current fiscal year. Auto sales have also witnessed a depressing trend in the first two months of the current fiscal year. Home sales are also not encouraging.
In the backdrop of all these, there were calls for RBI to announce a rate of 25 basis points when they meet on Monday.
Planning Commission Deputy Chairman Montek Singh Ahluwalia has even gone on record to say that the central bank must consider easing of inflation while deciding on the monetary policy on June 18.
However, RBI Governor D. Subbarao is more concerned about higher risk of inflation — especially food or retail inflation, which continues to be at an elevated level — widening of the current account deficit, and the strong slide of the Indian currency against the U.S. dollar in the last 10 days, especially after the S&P upgraded U.S. credit rating to stable that strengthened the greenback. The rupee weakened also due to an increased outflow of money from foreign institutional investors.
The central bank governor’s concerns seem to be genuine, given the small moderation of consumer price index to 9.31 percent in May from 9.39 percent in April and a rise in food prices from 10.61 percent in April to 10.65 percent in May.
The government and the RBI worked in tandem to curb import of gold in their efforts to control current account deficit. However, the strong fall in rupee has undoubtedly upset the calculations of the policymakers. The weak rupee meant higher import bill on oil, which, in turn, will likely increase inflationary pressures, particularly on food items. This will also widen the current account deficit in the absence of matching exports or inflows from foreign investors.
While brokerage houses such as HSBC anticipates a 25 basis points reduction in interests could be expected, others like Royal Bank of Scotland predicts that the sharp drop in rupee will not likely allow the RBI to cut interest rates. In fact, Reuters reported that of the 38 analysts it had surveyed, 28 predicted the central bank to hold its rates unchanged.
Obviously, doubts over cut in interest rates have lifted investors’ sentiments towards government bonds, which gained on Friday.
Therefore, looking from different perspectives and ground realities, the odds are definitely not in favor of the RBI announcing rate reductions on Monday. It might very well throw the ball in the government’s court again to announce more measures to stimulate growth.