RBI rate cuts - It's down to March or April

[K.Karthik Raja]

RBI rate cuts - It's down to March or April
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The RBI was much upbraided by economists and marketmen for not
cutting rates in the credit policy. Arguments ranged from pointing to
tell tale signs of economic slowdown to the potential of massive
capital inflows because of yawning interest rate differences.
.
But take a look at what has happened on the ground since January
this year. Yields have fallen from 7.9% to 7.4%, an effective 50-bps
fall, and now a slew of banks ranging from SBI to Canara Bank to Bank
of India and HDFC have cut rates.
.
On hindsight, it appears that RBI Governor Y.V. Reddy was
attempting a complex balancing act in the policy and looks like he has
succeeded reasonably. My hunch even on a reading of the policy was
that the governor wanted rates in the real economy to come down, but
wanted to stop short of giving any overt signals himself.
.
He was probably wary that with asset prices (both stocks and real
estate) still at stratospheric levels in January, an unadulterated
dovish signal from him would have fuelled the asset price rally even
further. It also could be that he wanted to retain his options given
the global turbulence. He therefore, chose to refrain from cutting the
policy rates.
.
But with a clever use of moral suasion hinted to banks that he is
not
only okay with rates coming down, but rather that he actually wants
lower rates. As of now, he appears to have succeeded. Most
institutions have cut rates and yet asset prices have not galloped,
though it is still early days.
.
ICICI Bank alone has chosen not to cut rates. Bank insiders say
they will prefer to wait and see through the end-March period, when
rates typically go up for a combination of factors: advance taxes suck
out a larger-than-usual amount of cash from the banking system, banks
chase deposits to bloat balance sheets and are usually unwilling to
lend in the overnight call market as it will require them to set aside
capital.
.
I have a hunch that ICICI is also not cutting rates because it is
suspicious of the governor till he comes out and gives a clear
unambiguous dovish signal.
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So when can one expect that much-awaited rate cut from the
governor? In the not very distant future, for sure. Besides the
yawning rate difference will get worse if U.S. Federal Reserve's Ben
Bernanke administers another much-awaited 50-bps rate cut in March.
That will further complicate the task of capital flows, exchange rate
management, inflation management, besides taxing the fisc.
.
More important are the signs of slowdown. The IIP numbers for
December may be a tad better than feared, but for the Oct-Dec quarter
which is a mediocre 8% against over 13% year ago. Besides these
numbers are the growing anecdotal evidence--news of job cuts in the IT
sector, bonus reductions, softening demand for airline tickets--all
indicating that the slowdown is catching up.
.
To be sure investment demand is robust, but with the equity
markets
tanking, domestic interest rates stubbornly high, export demand
slipping and consumption demand slowing, it may not be long before
investment decisions are also put off.
.
It appears these signs may not be lost on the governor. In fact,
his
reported response to journalists in Delhi smacks of an inter-policy
cut. Last Friday as he emerged from a meeting with the finance
minister, in Delhi, he was ambushed by journos asking him everything
from his thoughts on UBS licence to inflation numbers to the
possibility of rate cuts from the Fed.
"Wait till March", was the governor's response. It is unclear to which
question he was responding.He was probably merely brushing away
someone asking what he would do if the Fed cuts rates in March. But on
second thoughts, look at the RBI's record in previous years in March:
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RBI & THE IDEAS OF MARCH
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Mar 1, 1999 cut bank rate by 100 bps to 8%
Apr 1, 2000 cut bank rate by 100 bps
Mar 1, 2001 cut bank rate, repo and reverse repo by 50 bps
Mar 5, 2002 cut repo and reverse repo by 50 bps
Mar 3, 2003 cut repo and reverse repo by 50 bps
.
In five of the past 10 years, RBI has cut rates, just a day or two
after
the budget. In fact I remember in 2000, Reddy, who was then the deputy
governor, explaining that the smaller deficit has given the RBI
manoeuvrability on the rate front. A few days later, the RBI cut
rates. Are we in for a similar action this March? If not March, it
will be April. Not later, is my hunch.