0.25% OR 0.50% CUT? THE DOCTOR KNOWS WHATS BEST!

By Ruma Dubey

It was expected that the RBI Governor would announce a rate cut within a few hours after the Budget announcement or maybe the next day. But since that did not happen, the market and all analysts are pretty much certain that a rate cut WILL happen tomorrow. But the big uncertainty is whether it will be a token 0.25% or sharp 0.5%?

Inflation, which is what the RBI keeps a watch on and not industrial growth has been behaving itself, showing a steady decline despite the poor monsoon and drought in some parts of India. March CPI came down to 5.18% v/s 5.69% in Feb.

But what is hurting is industrial growth. IIP for Feb came down to 1.5%, a much sharper fall than what was expected. The worry now, really worrying, is that growth does need a kick start and all hopes, as usual are that RBI cutting rates will automatically help push up growth.

That is indeed being very immature in many ways. Yes, it will be a psychological push upwards but otherwise, a rate cut alone will not help. Banks are lending to those who really need, becoming extra cautious after the likes of Mallya duped them of over Rs.8000 crore. And then there is the question of whether or not banks will transmit the rate cut; at their behest the small savings rate has been cut, creating a level playing field. Now?

There are quite a few pointers to a sharper rate cut than the mandatory 0.25%.

• The Govt, in its Budget stuck to the fiscal deficit target of 3.5% for FY17. And this does put pressure on the RBI to cut rates. This sticking to the fiscal deficit target shows fiscal prudence and will thus force RBI to act.
• Inflation is under control, at least that it how it is looking now.
• Monsoon is expected to be normal this year – that’s a huge relief after two years of very sporadic and patchy rainfall.
• Growth is hurting – it is high time attention is paid to perking up growth. Rate cut is just another way of psychologically signaling that things are getting better.
• We could see a CRR cut too as banks have been complaining about a tight liquidity situation.
• The US Fed has indicated that it will remain largely “accommodative” this year and two rate hikes are what we could see on the upper end.
• Crude oil is expected to remain in the range of $35-40 as Iran has ruled out a production freeze, following which Saudi too categorically ruled out cutting down production. Prices have in fact started falling again.

At this juncture a sharper rate cut of 0.50% can do what a mere 0.25% cannot do::

• Return of growth will lead to higher revenues and a lower deficit.
• Lower rates will cut costs for companies, boost demand and increase output
• Lower rates could lead to fresh investment in capacities
• Rate cut will boost sentiment not just for companies but also markets, which in turn will bring in more FIIs, leading to increase in capital inflows and bring down the current account deficit.

Well, Dr.Rajan knows all this and more. He should not come under any pressure – neither from the Govt nor the market forces to make an economic decision. He has always done what is good for the economy; in fact at this point of time, he seems to be the only Govt agent working towards the good of the people! Thus he should do what is best for the economy and not bow down to the gallery.

For the markets tomorrow, if the rates are cut by 50 bps, the bulls will trample the bears; if the rate cut is 25 bps, it would rally in the green as it would be more or less like a “ho-hum” already discounted kind of rally.