The market may have its views on whether RBI will cut policy rates in its forthcoming policy review on the 29th of March. Markets position for such events and if the event, which is rate cuts, goes against the position, markets offload the positions and move on to the next event.
Apart from the market taking positions on rate cut expectations, there are the â€œthinkersâ€ who have a view on whether RBI should cut interest rates or not. In the current economic scenario the opinion is evenly divided between yes for rate cuts and no for rate cuts. The reasons for the yes and no are the different interpretation of the same data, whether it is GDP growth, Inflation (WPI or CPI) or Fiscal and Current Account Deficit. For the records GDP growth for the third quarter 2012-13 was at 4.5% the lowest in a decade, WPI (Wholesale Price Index) inflation is at around 6.6% expected in 2013 the lowest in a year, CPI (Consumer Price Index) is over 10%, Fiscal Deficit is at 5.2% of GDP while Current Account Deficit is expected at around 4.5% of GDP for 2012-13.
The Yes to rate cut thinkers point out to weak growth and falling WPI while the No to rate cut thinkers point out to high CPI and high fiscal and current account deficits. Who is right or who is wrong, only time will tell. RBI in the meanwhile has the difficult job of managing a difficult macro economic environment and it gets booed if it cuts rates and it gets booed if its does not cut rates. RBI should do its job to the best of its abilities and it is best it ignores the market and the thinkers.
Ok, so does the economy require rate cuts or not? A rate cut of 25bps on the Repo will bring down the repo rate to 7.5%. Banks are borrowing around Rs 100,000 crores from the RBI on a daily basis and a 25bps rate cut will bring down the cost of overnight borrowing for banks. Banks will not pass on the rate cuts to its borrowers given that they are still short of liquidity and hence rate cuts may not work to revive economic growth. Rate cuts, even if they work, work with a lag and with the help of other factors such as lower government borrowing, improved system liquidity and rising consumer and business confidence. One can safely say that in terms of reviving growth a 25bps rate cut will have no effect.
However the question to ask is, will no rate cuts help the economy? Lack of rate cuts lowers sentiments amongst businesses and consumers leading to falling investment demand and falling consumer demand. Status quo on rates will not bring down inflation nor will it cut fiscal or current account deficit. Banks will hoard liquidity but will not necessarily raise deposit rates to lure depositors. Banks have enough excess government bonds to pledge with the RBI for Repo funds. No rate cuts in a weak economic growth environment is likely to exacerbate the fall in growth that could have long term implications.
Net to net, even though rate cuts will not help the economy, the consequences of no rate cuts look worse. The economy is better off with rate cuts than no rate cuts.
Table 1. Key Economic Indicators
US economic data has been positive with February 2013 jobs report showing 236,000 jobs being added in the economy. The consensus estimates for by economists was around 195,000 job additions. US unemployment rate fell to a four year low of 7.7% in February. US new home sales rose 16% in January 2013 to the highest level seen since July 2008. US service sector expanded for the 38th consecutive month in February.
US economy is showing resilience in the face of spending cuts and tax increases that kicked in from the beginning of 2013.
China showed mixed data with exports rising 21.2% in February while imports fell 15.2%. Consumer Price Inflation for February came in at 3.2%, the highest in ten months. Chinaâ€™s industrial growth in January 2013 was the weakest since 2009.
China has adopted a growth rate of 7.5% for 2013 suggesting that the country is looking to stabilize from over investments and property bubbles. China has been growing at double digit levels in the most part of 2000-2012 period.
Eurozone GDP contracted by 0.6% in the fourth quarter of 2012 while its unemployment rate rose to a record high of 11.9% in January 2013 from 11.8% seen in December 2012. Eurozone economy is forecast to show no growth in 2013.
Eurozone has not got over its sovereign debt issues with citizens of countries such as Italy voting against austerity. Eurozone economic recovery is going to be a slow and long drawn out process.