Expectations are high that the Reserve Bank of India will reduce rates in its forthcoming policy review on Thursday by at least 25 basis points (bps). With GDP growth touching a 17-quarter low of 5.8 per cent in Q4 FY19, market watchers even anticipate a change in policy stance to accommodative. Currently, it’s set at neutral.
“This (change in stance) would be essentially driven by a broad-based slowdown in economic momentum in recent months, modest improvement in liquidity conditions (credit-deposit ratio, corporate bond spreads) — but far from normal and inflation dynamics, which remain benign,” said brokerage Edelweiss Research.
It added that with the global economy slowing, western central banks also turned slightly dovish, particularly the Fed. “Thus, a rate cut by the RBI is highly likely, and may not be the last one in our view,” the agency noted.
What’s perhaps more important is ensuring quick transmission of policy rates given that the last two rate cuts hardly were passed on to end customers. While G-Sec yields have surely eased, the credit-deposit ratio in the banking system still remains elevated and corporate bond spreads have eased only modestly from their recent highs. The tight liquidity, in our view, is partially the result of high growth in currency in circulation and lingering risk aversion among NBFCs. Hence, it is critical that the RBI keeps up durable liquidity injections.
“Liquidity woes in banking system are far from over. The silver lining in this the expectation of government spending, this is likely to reduce the liquidity deficit in the system. Also the currency in circulation which had shown sharp spikes due to elections, is also likely to gradually recede, impacting liquidity favourably,” noted Lakshmi Iyer, Chief Investment Officer (Debt) & Head Products, Kotak Mahindra Asset Management Company. She added that given the global as also domestic scenario, the MPC may well choose to gratify the markets with a benchmark rate cut. What is more important for markets is the MPC guidance. As for inflation, it remains benign both in terms of headline number and its underlying dynamics. Retail inflation picked up steam last month, which some consider it as a reflection of normalisation of unusually low food inflation, while core inflation eased.
Global trade and industrial activity is clearly slowing while the Fed and ECB and other central banks have given up tightening and turned marginally dovish, which leaves room for emerging market central banks including India to cut rates, said Edelweiss.