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Repo Rate Cut

Posted on 13-Mar-2020 Comments  0

Repo Rate Cut

It’s time for the RBI to intervene and cut rates at the earliest

In the immediate aftermath of the Fed rate cut in March-20, there were strong expectations that the RBI would follow suit. However, the RBI has chosen to go slow and avoided jumping into a rate cut. Is it really time for the RBI to act or should the RBI wait for more time?

Time to act is now

The typical refrain by most market analysts is that the rate cuts by the US in the month of March could not prevent the vertical fall in the DJIA. In fact, the Dow fell by nearly 29% from its peak levels in just one month. This happened despite the Fed cutting rates by 50 basis points in early March. The argument is also that over the last 11 years, the US had kept rates low and liquidity highly comfortable for long periods of time. But that still did not result in a pick-up in growth. But somehow, both these may not really be valid arguments in the current global economic context.

The reason RBI must think of a rate cut is that it already paused in December and February. That gives them leeway to cut rates by 25-50 basis points. Also, the main purpose of the rate cut at this juncture is twofold. The first purpose is to synchronize monetary policy with the global central banks. That is a safer approach in such challenging times. The second purpose is to boost confidence of consumers and businesses and that can be best achieved if the RBI gives a clear signal that it is willing to loosen.

Inflation is tapering

One reason the RBI had put rate cuts on hold in last two policy announcements was the sharp spike in inflation. For the month of February, CPI inflation has come down sharply from 7.59% to 6.58%. While it is still above the RBI outer limit of 6%, the fall is a good sign that inflation may be on the right path. Also, the big trigger for lower inflation has come from a sharp fall in food inflation that has fallen from 13.2% to 10.4%. That certainly gives breathing room for the RBI to cut rates for a start and then wait for further inflation data to follow up. The bumper Rabi crop and weak crude prices should also work in favor of lower inflation.

There is the forex comfort

One reason why the RBI has normally been cautious about rate cuts is that it makes Indian debt paper unattractive for foreign investors. But that should not be a worry for two reasons. Firstly, the US yield curve has dipped sharply with even the 30-year bond yields under 1%. Even at 6% India yields, it enjoys a yield spread of more than 500 bps over the US benchmark. Secondly, with a forex chest of $487 billion, RBI has the required firepower to support the rupee. That means; FPIs would always be looking to enter the Indian market each time RBI support to rupee emerges. That will keep FPIs routinely interested in Indian debt and equity! 

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