Reserve Bank of India (RBI) is expected to hold the key policy repo rate at 7.25 per cent on Tuesday in its bimonthly monetary policy review but would snip it again before the end of the year by another 25 basis points (bps), as per a VCCircle survey of economists.
Of the 21 economists polled, only three expect RBI to cut rate on August 4 while median forecast suggests a rate cut to 7 per cent in October-December quarter.
While the central bank has delivered three rate cuts of 25 bps each this year, it hasn't made much impact on lending as banks have been reluctant to pass on the rate cut to the consumers. But with inflation still below the 6 per cent mark as the upper end of a target band by January 2016, RBI governor Raghuram Rajan has the room to cut rates hoping to boost the economy.
Monsoon, inflation and industrial production
The central bank governor in the last policy review had pointed out that the bank will have to wait for the El Nino effect to play out before it takes further decision to cut policy rate. With the monsoon being better than forecasted earlier and as yet only limited impact on food prices due to less than normal rainfall, inflation is expected to remain subdued. Inflation will also be tempered due to a slide in oil prices due to the Iran deal.
One of the strongest cases for a rate cut comes from the industrial side. While the government has put its weight behind the Make in India campaign, the industrial economy is yet to pick up as expected. Another rate cut by Rajan may provide that impetus to boost the ailing manufacturing sector in the economy.
The MPC tangle
The RBI's stance would also factor in the development in the US where the Federal Reserve is expected to hike rate after half a decade. Moreover, Rajan may have to fight on another front in deciding the constitution of the Monetary Policy Committee.
The government and the RBI decided to introduce the MPC framework to bring in more transparency for rate decisions this year. The RBI was set with a flexible inflation target of 4 per cent consumer inflation with a buffer of 200 basis points or 2 percentage i.e., it is aiming to restrict retail price rise to 2-6 per cent range.
But the government and the RBI have been at logger heads regarding the constitution of the committee while RBI is favouring a constitution with limited government control, the government in the latest draft of Indian Financial Code guidelines decided to clip RBI's wings by including more members of the government in rate decision.
With the government assuring the RBI that the bank will still have control what remains to be seen is whether they are able to reach an agreement. For now governor Rajan will have the task of deciding whether he wants in to cave in to the pressure of a rate cut or if the central bank will hold on to the rates until the benefits are passed on to the consumer.