RBI CREDIT POLICY - HERALDS RATE CUT CYCLE

By Ruma Dubey

All were hoping that RBI would go for the jugular and announce a 50 bps rate cut but in the evening, RBI presented a very somber picture of the economy, cutting GDP forecast from 5.7% estimated earlier to 5.5% for FY13. This made all recalibrate their optimistic stance and expectations were muted today morning before the policy. Though all felt a 25 bps was more likely, the markets were uncertain and it was in the red before the policy.

And Mr.Subbarao did not disappoint; he announced the expected 25 bps rate cut in repo rates to 7.75% and surprised all, by adding on even a 25 bps cut in CRR, infusing Rs.18,000 crore liquidity into the system. He had last cut rates by 50 bps in April, 2012. These changes have since come into effect immediately. Post this, reverse repo gets adjusted to 6.75% and bank rate to 8.75%.

The immediate reaction to this rate cut would be encouragement to investment thereby supporting growth, medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation and there will be an improvement in liquidity conditions to support credit flow.

Commodity prices have remained stable over the few months which in itself indicate that things are now on a cusp and we see indications that the consumption gap is fast closing. Moreover, the global growth cycle is at a turning point and once that picks up, crude and commodity prices will shoot through the roof. Inflation pressure is bound to emerge in the second half of 2013. And based on this logic, it would then be too naïve to expect the rate cut cycle to be aggressive. At the most another 25-50 bps is what we can see in the coming months.

Will the banks follow suit? Not with immediate effect but in a week’s time we could see most banks reducing rates. Banks will be encouraged, maybe most will not rush with a rate cut but the RBI has signaled today that the rate cycle will now reverse, will only go down in the months to come. Hopefully, just as RBI has cut rates to boost growth, banks also toe the line and go for full transmission and cut rate over the next one week. This transmission is what will buoy sentiments.

Current account and fiscal account deficits hover like dark clouds. But the Govt is working on that and the Budget could see steep hike in import duties. But over the next 2 months, we could see the effect of hike in gold duties and exports are seasonally expected to do well in March. So let us hope, the optimistic sentiment revives investments, growth and FDI inflows and maybe then some of our deficit woes could get resolved.

This rate cut is obviously good news for the equity markets. It is on a positive momentum now and if the Budget delivers as expected, then we can say for sure than the bulls have arrived. Equity markets will see today’s rate cut as a continuation of the reform process initiated by the Govt.  The slew of positive announcements from the Govt, record investment from FIIs, which is expected to surpass $3 billion in January, are all good news for the market to follow. Yet, post this we could see a plateau market before the budget with stock specific activity though the underlying mood will remain optimistic. Yes, the market momentum will continue to remain positive and all eyes will now be on the upcoming Budget.

There is a very valid worry that domestic institutions are not investing like the FIIs but as post the policy today, which is the cue they might have been waiting for, we could the return of domestic institutions. A sustained positive market would mean people will come back to equity, many getting out realty and gold. And that will be good for the market and the economy. Makes sense for one to remain overweight in equity and do not yet give up on fixed income products, wait till the end of the year.