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Reuters Photo Credit: Raghuram Rajan

Two reasons why RBI may cut rate again and two reasons why it may not

02 February, 2015

The Reserve Bank of India (RBI) is set to announce its sixth bi-monthly monetary policy review on Tuesday. Notably, the country’s monetary authority had surprised with a rate cut just two weeks ago and that has split the street view on whether RBI governor Raghuram Rajan would like to hold on to the policy rates for now.

Here’s a quick take on why Rajan may still go ahead with a cut and conversely why he may not.

Why RBI may cut rates

The biggest factor which may favour a rate cut is the still tentative revival in parts of the economy with the manufacturing sector yet to break out of the slowdown. The latest statistics on eight core sectors show growth has slowed down to three-month low of 2.4 per cent in December. The eight core sector industries — coal, crude oil, natural gas, refinery products, fertiliser, steel, cement and electricity — had expanded by 6.7 per cent in November, 2014 and 4 per cent in December 2013. The HSBC PMI survey also points to a slowdown in factory activity. The core sector contributes over one-third of the overall industrial production, a parameter tracked closely by RBI and factored into while framing its monetary policy.

Secondly, inflation remains well under control. Consumer inflation, which is now the key guiding factor for monetary policy as against wholesale inflation in the past, was pegged at 5 per cent in December. This is much below RBI’s target of bringing it down to 8 per cent by January 2015 and 6 per cent by January 2016. Consumer inflation had proved stubborn till recently due to high price of food products but a sharp drop in fuel prices and moderation in food prices in the last few months has brought inflation under control.

Why it may not cut

The main reason why it may not snip the policy rate again is simply that it did it just two weeks ago. If it had not made that surprise move, all bets would have been on a rate cut on February 3. Earlier, the view was split whether RBI would cut rate in February or April, when it holds the next policy review meet. But that changed with 25 bps cut on January 15. Rajan had been steadfast in holding on to widespread calls for a rate cut earlier.

Secondly, there have been no significant change in the Indian economy since the last rate cut which merits a rate cut. While the government has come out with a restated GDP growth rate for FY14 which shows the economy is at a healthy state, that is largely due to accounting change and would not affect RBI’s immediate stance. Moreover, RBI may want to watch out for the Union Budget due later this month which would give a clearer picture of the future direction of fiscal policy. Rajan has shown he would not shy away from making interim rate cuts between scheduled monetary policy reviews and since his last cut came right after the latest inflation data for December, he may well like to see how it is absorbed before taking a fresh call or push through a new cut after January’s inflation data is released in the middle of this month.

(Edited by Joby Puthuparampil Johnson)


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Two reasons why RBI may cut rate again and two reasons why it may not

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