Rate cut by Reserve Bank next week a near certainty, say economists

MUMBAI: Minutes after RBI’s blunt move to soak up liquidity from banks, a fund house chief executive wrote a long text to members of his WhatsApp group justifying the hike in the cash reserve ratio (CRR) and how it would stabilise markets. A day later, when the governor said it was a temporary measure, he joined those cheering in the bond market. These men know that a dip in growth and surge in deposits would force the central bank to lower interest rates sooner than later — an action that pushes up bond prices and softens bond yields.

What’s bad news for the economy is good news for the bond market, which has recovered most of the losses from the shock of last Saturday’s CRR hike.

“A rate cut now is not a conflict with the CRR hike because this hike will be eventually rolled back. The economy is at a standstill now, so we should expect a cut. We were always expecting a 25-basis-point (bps) cut in December and another 25 bps later in the fiscal, and we are sticking to our prediction,” said Indranil Sengupta, chief India economist at Bank of America-Merrill Lynch (BofA-ML). Pradip Madhav, MD of STCI Primary Dealer — one of the country’s largest bond houses — said he would not rule out even a 50-bps cut by RBI.

BofA-ML has cut its GDP forecast by a further 50 basis points to 6.9% in FY17. It expects a total of 75 bps cut by September 2017.

Most economists believe a 25-bps rate cut to be a certainty next week as the central bank needs to support small and medium enterprises (SMEs) which have been hit by demonetisation of high-value notes.

CRR Hike an ‘Extraordinary’ Step
We were always expecting a 25-bps cut in December. We now expect a further 25-bps cut in February because of the slowdown in growth. The CRR hike announced a few days ago was just an extraordinary liquidity-absorbing measure rather than policy rate decision,” said Anubhuti Sahay, chief India economist at Standard Chartered.

On November 26, RBI asked banks to keep all incremental deposits garnered between September 16 and November 11 with the central bank to absorb the avalanche of liquidity in the banking sector after demonetisation was announced on November 8. RBI will review these measures on December 9.

There is a widely shared perception that RBI may resort to more sophisticated policy tools to mop up liquidity rather than impounding incremental deposits as CRR. Even though many may be hoping for a more aggressive rate cut by RBI in Wednesday’s monetary policy, chances are that the central bank may hold back ammunition for the future as the full impact of demonetisation unfolds by end March.

Bond yields, which shot up 17-18 basis points soon after the CRR hike, have fallen almost 10 basis points since then.

“RBI is expected to cut rates to push transmission and lower the cost of credit especially for small enterprises. Liquidity is adequate so a rate cut should in all probability bring working capital and short-term rates lower,” said Saugata Bhattacharya, chief economist at Axis Bank.

Figures released on Wednesday showed that India’s GDP (gross domestic product) slowed to 7.3% in the second quarter ended September 2016 down from 7.6% in the same period last year. However, expectations are that the demand destruction caused by demonetisation will hurt growth more severely in the second half of the year with the most conservative estimates pointing to at least a 50-bps slippage in GDP growth in the current quarter.

“Lower growth for a few quarters means the output gap will take longer to close, and inflation will be lower, making us confident on our 25-bps rate cut call for December 7,” said Pranjul Bhandari, chief India economist at HSBC.