Every man and his dog wants the interest rate in India to drop. Indeed, it will come down in the backdrop of a sharp fall in inflation, but will Reserve Bank of India (RBI) governor Raghuram Rajan oblige them on Tuesday when the Indian central bank announces its bimonthly monetary policy? My gut feeling is—no. A rate cut may happen in February when RBI announces its next policy, but in terms of probability, the annual monetary policy in April seems to be a better bet for a quarter-percentage-point cut in RBI’s repurchase, or repo, rate.
Pressure has been mounting on Rajan for weeks, ever since the release of data on inflation. It intensified with oil prices dropping to a four-and-a-half-year low. Finance minister Arun Jaitley has been pushing for a rate cut to boost growth in Asia’s third largest economy. Of course, every time Jaitley calls for a rate cut, he caveats it with a customary line, saying ultimately the decision will be taken by RBI and he is merely expressing his opinion.
This is an art perfected by India’s successive finance ministers and, to be fair to Jaitley, his predecessors P. Chidambaram and Pranab Mukherjee, had been far more aggressive in putting pressure on the central bank for a rate cut. At a time when the government is mulling over giving RBI a formal inflation target and setting up a panel to decide on monetary policy, the finance minister’s frequent expressions of personal opinion on the trajectory of interest rate look a bit odd, to put it mildly.
Even some members of the technical advisory committee on monetary policy have been talking about a rate cut. I presume these members were in favour of a rate cut at the last committee meeting before the October policy (but that their arguments did not cut ice with Rajan) and now they are making it public. Since the committee is advisory in nature and the opinion of its members—who are not part of the central bank—is not binding on RBI, there is nothing wrong with the committee members expressing their views openly.
Among corporations demanding a rate cut claiming that only a lower interest rate will change the investment climate and encourage companies to borrow when the cost comes down, the voice of the debt-laden companies is louder than those of others. They want the rate to decline as that will help them bring down the cost of servicing a massive debt burden. A recent India Rating estimate, based on an analysis of the credit metrics of the top 500 corporate borrowers in fiscal year 2014, pegs the aggregate debt of these companies at Rs.28.76 trillion, or 73% of the total bank lending to the industry, services and export sectors. Around 82 of these 500 borrowers have already been formally tagged as financially distressed, and another 83, accounting for 9% of the overall debt of the group, have severely stretched credit metrics. The operating profits of most of these 83 corporations barely cover the interest cost to be serviced.
The last time Rajan raised the repo rate was in June—by a quarter percentage point to 8%. At that time, the RBI policy document had said that “if the economy stays on this course, further policy tightening will not be warranted” and “if disinflation…is faster than currently anticipated, it will provide headroom for an easing of the policy stance”. Later, in August, while maintaining the status quo on the rate front, it said the upside risks to the target of containing retail inflation within 8% by January 2015 remained and, therefore, it was “appropriate to continue maintaining a vigilant monetary policy stance”. And, its last policy statement, on 30 September, said that “the balance of risks” to achieving 6% by January 2016 “is still to the upside”, adding: “the future policy stance will be influenced by the Reserve Bank’s projections of inflation relative to the medium-term objective (6% by January 2016), while being contingent on incoming data.” It also pointed out that the “base effects will also temper inflation in the next few months only to reverse towards the end of the year. The Reserve Bank will look through base effects.”
True to his words, Rajan has not tightened the policy any more. Indeed, a drop in inflation has provided headroom for easing of policy stance, but since this has happened because of base effects and the trend may not continue beyond November, Rajan is unlikely to be in a hurry to cut the rates.
In accordance with the so-called glide path, drafted by an RBI panel headed by its deputy governor Urjit Patel, the Indian central bank is targeting retail inflation at 8% in January 2015 to 6% in January 2016.
Wholesale price inflation dropped for the fifth consecutive month to 1.77% in October, its slowest since October 2009; retail inflation at 5.52% has been the slowest since January 2012 when the current series started. A year ago, in October 2013, it was 10.17%. Equally important is the fact that non-food, non-oil, so-called core inflation or manufacturing inflation has been slowing. Core retail inflation remained unchanged at 5.9%, and core wholesale inflation slumped to 2.5% in October, reflecting sustained disinflationary pressure and lower pricing power by businesses. Finally, food inflation, one of the key driving factors, slowed to 2.7% in October, from 9.6% in May—its lowest level since February 2012.
The reasons behind a sharp fall in inflation include a dramatic drop in international commodity as well as oil prices and the prices of food. The government has also done its bit by effecting a very modest hike in minimum support prices of agriculture produce and offloading food stocks even as a stable currency has not allowed imported inflation to seep through. The market has been expecting a rate cut; the rates of overnight indexed swaps are a testimony to that. The yield on 10-year benchmark, which was 8.49% in September during the last policy review, has dropped to 8.08% and the corporate bond yield has fallen even sharper. As a result of this, the spread between the government and corporate bond yield has shrunk from around 60-70 basis points to 10-20 basis points. A basis point is one-hundredth of a percentage point. Foreign institutional investors’ appetite for Indian paper has contributed to this.
Indeed, Rajan will take into account all these factors, but he may not be moved as yet for a rate cut. Inflation will fall further in November—retail inflation may drop below 5% and wholesale inflation below 1.5%, but the trend will reverse in the coming months when the statistical base effect wears off even as inflationary expectations continue to remain high. Besides, nobody knows how long crude oil prices will keep on dropping. So, Rajan may prefer to wait and be sure about the inflation trajectory before taking a call on the rate cut. He may take the decision in February if he is convinced or would like to wait for the government to demonstrate its commitment to fiscal correction in the February budget before announcing a rate cut in April. A rate cut on Tuesday will dent RBI’s credibility, particularly if inflation reverses its trend a couple of months later. Rajan has waged a war against inflation and he cannot afford to give up the fight halfway through. Only after bottling the inflation genie should he go for easing monetary policy.
Banks, however, may not wait for the RBI action to bring down their loan rates. Most banks have pared deposit rates in the past few weeks and at least one bank has cut its base rate or minimum lending rate. With credit offtake at a multi-year low even in the so-called busy season, I will not be surprised if banks start cutting their base rate in December-January and bring down the cost of money for their borrowers.
Pressure has been mounting on Rajan for weeks, ever since the release of data on inflation. It intensified with oil prices dropping to a four-and-a-half-year low. Finance minister Arun Jaitley has been pushing for a rate cut to boost growth in Asia’s third largest economy. Of course, every time Jaitley calls for a rate cut, he caveats it with a customary line, saying ultimately the decision will be taken by RBI and he is merely expressing his opinion.
This is an art perfected by India’s successive finance ministers and, to be fair to Jaitley, his predecessors P. Chidambaram and Pranab Mukherjee, had been far more aggressive in putting pressure on the central bank for a rate cut. At a time when the government is mulling over giving RBI a formal inflation target and setting up a panel to decide on monetary policy, the finance minister’s frequent expressions of personal opinion on the trajectory of interest rate look a bit odd, to put it mildly.
Even some members of the technical advisory committee on monetary policy have been talking about a rate cut. I presume these members were in favour of a rate cut at the last committee meeting before the October policy (but that their arguments did not cut ice with Rajan) and now they are making it public. Since the committee is advisory in nature and the opinion of its members—who are not part of the central bank—is not binding on RBI, there is nothing wrong with the committee members expressing their views openly.
Among corporations demanding a rate cut claiming that only a lower interest rate will change the investment climate and encourage companies to borrow when the cost comes down, the voice of the debt-laden companies is louder than those of others. They want the rate to decline as that will help them bring down the cost of servicing a massive debt burden. A recent India Rating estimate, based on an analysis of the credit metrics of the top 500 corporate borrowers in fiscal year 2014, pegs the aggregate debt of these companies at Rs.28.76 trillion, or 73% of the total bank lending to the industry, services and export sectors. Around 82 of these 500 borrowers have already been formally tagged as financially distressed, and another 83, accounting for 9% of the overall debt of the group, have severely stretched credit metrics. The operating profits of most of these 83 corporations barely cover the interest cost to be serviced.
The last time Rajan raised the repo rate was in June—by a quarter percentage point to 8%. At that time, the RBI policy document had said that “if the economy stays on this course, further policy tightening will not be warranted” and “if disinflation…is faster than currently anticipated, it will provide headroom for an easing of the policy stance”. Later, in August, while maintaining the status quo on the rate front, it said the upside risks to the target of containing retail inflation within 8% by January 2015 remained and, therefore, it was “appropriate to continue maintaining a vigilant monetary policy stance”. And, its last policy statement, on 30 September, said that “the balance of risks” to achieving 6% by January 2016 “is still to the upside”, adding: “the future policy stance will be influenced by the Reserve Bank’s projections of inflation relative to the medium-term objective (6% by January 2016), while being contingent on incoming data.” It also pointed out that the “base effects will also temper inflation in the next few months only to reverse towards the end of the year. The Reserve Bank will look through base effects.”
True to his words, Rajan has not tightened the policy any more. Indeed, a drop in inflation has provided headroom for easing of policy stance, but since this has happened because of base effects and the trend may not continue beyond November, Rajan is unlikely to be in a hurry to cut the rates.
In accordance with the so-called glide path, drafted by an RBI panel headed by its deputy governor Urjit Patel, the Indian central bank is targeting retail inflation at 8% in January 2015 to 6% in January 2016.
Wholesale price inflation dropped for the fifth consecutive month to 1.77% in October, its slowest since October 2009; retail inflation at 5.52% has been the slowest since January 2012 when the current series started. A year ago, in October 2013, it was 10.17%. Equally important is the fact that non-food, non-oil, so-called core inflation or manufacturing inflation has been slowing. Core retail inflation remained unchanged at 5.9%, and core wholesale inflation slumped to 2.5% in October, reflecting sustained disinflationary pressure and lower pricing power by businesses. Finally, food inflation, one of the key driving factors, slowed to 2.7% in October, from 9.6% in May—its lowest level since February 2012.
The reasons behind a sharp fall in inflation include a dramatic drop in international commodity as well as oil prices and the prices of food. The government has also done its bit by effecting a very modest hike in minimum support prices of agriculture produce and offloading food stocks even as a stable currency has not allowed imported inflation to seep through. The market has been expecting a rate cut; the rates of overnight indexed swaps are a testimony to that. The yield on 10-year benchmark, which was 8.49% in September during the last policy review, has dropped to 8.08% and the corporate bond yield has fallen even sharper. As a result of this, the spread between the government and corporate bond yield has shrunk from around 60-70 basis points to 10-20 basis points. A basis point is one-hundredth of a percentage point. Foreign institutional investors’ appetite for Indian paper has contributed to this.
Indeed, Rajan will take into account all these factors, but he may not be moved as yet for a rate cut. Inflation will fall further in November—retail inflation may drop below 5% and wholesale inflation below 1.5%, but the trend will reverse in the coming months when the statistical base effect wears off even as inflationary expectations continue to remain high. Besides, nobody knows how long crude oil prices will keep on dropping. So, Rajan may prefer to wait and be sure about the inflation trajectory before taking a call on the rate cut. He may take the decision in February if he is convinced or would like to wait for the government to demonstrate its commitment to fiscal correction in the February budget before announcing a rate cut in April. A rate cut on Tuesday will dent RBI’s credibility, particularly if inflation reverses its trend a couple of months later. Rajan has waged a war against inflation and he cannot afford to give up the fight halfway through. Only after bottling the inflation genie should he go for easing monetary policy.
Banks, however, may not wait for the RBI action to bring down their loan rates. Most banks have pared deposit rates in the past few weeks and at least one bank has cut its base rate or minimum lending rate. With credit offtake at a multi-year low even in the so-called busy season, I will not be surprised if banks start cutting their base rate in December-January and bring down the cost of money for their borrowers.
