The credit policy to be announced on October 9 is going to be special and different for a variety of reasons. Normally what one looks from the policy is whether the repo rate is going to be changed or not. This is so because as a saver one is interested to know if the deposits opened will receive a higher or lower interest rate. This may not always hold because banks have their own reason for changing deposit rates depending on their requirements. But any cut in the repo rate will not be good news. From the point of view of a borrower, a lower repo rate will be beneficial as all retail loans are linked to what is called an external benchmark, which is the repo rate here. Hence if a housing loan is reckoned at say the repo rate plus 200 bps which is presently 8.5%, a reduction of 25 bps in the policy rate will bring the cost down to 8.25%. Therefore there would be an asymmetric impact on the customers depending on whether it is a deposit holder or borrower.
The present situation is quite different given the developments that have taken place. To begin with there would be new members appointed to the Committee. The Monetary Policy Committee comprises three members from RBI and three external experts. The Committee in the last term had a slight tilt towards a rate cut with 2 of the 3 external members voting for it in August. In the June meeting 1 of the 3 votes for a cut. With the new composition of the Committee, it would be interesting to see how the members view the situation.
Second the variable which is targeted is inflation which has been quite benign in the last 2 months at 3.6% and 3.7% in July and August respectively. The RBI is targeting an inflation rate of 4% with a two percent band on either side. Therefore, prima facie the number looks to be below the target. However, a point which has been made by the RBI in various forums is that the central bank cannot be looking just at the current inflation rate only but has to form judgments or conjectures on future inflation. This is necessary because the repo rate has been at 6.5% for a long time and any change will mean a pivot that should not ideally be reversed in the next couple of months. This can happen only if one is firm on the future inflation view.
The RBI’s current forecasts of inflation are relevant here. For Q2, the forecast is 4.4% which is to rise to 4.7% in Q3 before coming down to 4.3% and will average 4.5% for the year. The Q2 forecasts could come in lower than 4.4% given the inflation rates in the months of July and August. It has been pointed out that the low numbers so far this quarter are due to the high base effect which means that since inflation was high last year, on this base, the growth would optically seem lower.
But there is hope that prices would cool down once the kharif harvest enters the market. The rains have been good and bountiful and the crop is likely to be normal. The concern would be more on non-crops in the area of horticulture where prices are very high for onions, potatoes and tomatoes. This can skew the picture. Also as seen in the past, a late withdrawal of monsoon or excess rains in any pocket at this stage can impact output. As this picture will get clearer only by November, it would be pragmatic to wait and watch before taking a call on inflation trajectory.
Besides, some elements of non-food inflation also called core inflation are showing some signs of spiking up like telecommunication charges as well as consumer personal products as higher input prices are being transmitted by manufacturers. A clearer picture will emerge after a couple of months.
At a different level, there have been some interesting developments in other geographies. The US Federal reserve has lowered their target rate by 50 bps to 4.5-4.75%. This was a big cut and while some sections in the market did expect it, indications are that there would be more cuts in the offing. The ‘dot plot’ indicates that there could be another 50 bps cut this year followed by 100 bps next year and another 50 bps in 2026. What is important is that there has been a pivot in policy to lower rates and depending on the evolving conditions would glide downwards over time. The ECB and Bank of England have also lowered their rates earlier. The fact that rates are moving down globally also raises expectations that the RBI should be following suit soon. The question is how soon will this be done?
It has been maintained that the Fed action is not a primary motivating factor for RBI action as domestic conditions matter more. While Fed action is considered in the discourse as it has an impact on currency movements and forex flows, it is not the overarching argument as the direct impact on inflation is not significant. Right now, growth appears to be on the right path and it does look like that 7% plus is something that will be achieved. Inflation is the unknown though all indications are that it will remain lower. Crude oil prices have come down to the sub-$ 80 mark, which actually opens the door for possible lowering of duties on fuel products which can further bring inflation down.
Under these conditions there are strong reasons for lowering the repo rate. But waiting till November would bring more certainty in the policy stance as the inflation picture gets firmer. Hence with equally convincing arguments on both sides it would be of interest to see which way the MPC decides on October 9.
The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal
