However, despite the tapering of inflation and the green shoots of recovery shown by the IIP, the RBI may not be inclined to cut repo rates any time soon. Here are 5 reasons why the RBI may not be too inclined to cut rates despite some positive trends from IIP and CPI inflation..
- The actual trajectory of the CPI inflation will only be known after the Kharif output for the year is known. That will be a function of how the monsoons pan out during the year. Last year was predicted to be a normal monsoon but the Kharif output was below expectations. Hence the RBI may be wary of cutting repo rates unless it has clarity that food inflation, the major component of CPI inflation, is well and truly under control.
- Oil inflation is still the X factor. While crude oil prices have tapered down below the $65/bbl mark, the demand-supply is likely to remain ambiguous till the OPEC and Russia continue to maintain production cuts of 1.8 million barrels per day. Any move closer to the $70/bbl mark could lead to a sharp rise in CPI inflation due to its downstream effects. Also the Saudi Aramco IPO coming out next year will help to hold oil prices at elevated levels.
- One way for the RBI to look at the IIP numbers would be to cut rates to aid a nascent recovery. But the RBI would still await clarity on the base effect. The months of November, December and January have seen extremely positive IIP growth due to the base effect of demonetization. Unless the IIP is assessed in the coming months, shorn of the base effect, the RBI may not be too keen to cut rates to aid a recovery in growth.
- The RBI realizes that any rate cut at this point of time may not add value till the time it gets to grips with the problem of NPAs in PSBs. It is currently estimated to be around $233 billion but if the PNB fiasco is any indication then the actual figure may be much higher. With that kind of a NPA overhang, it is hard to imagine rate cuts spurring any kind of recovery in credit growth. RBI may as well wait for the full impact of the recovery process including the NCLT process in progress under the IBC.
- Lastly, there is the major issue of foreign capital flows, especially into the bond markets. The reason we have not seen any sell-off in bonds by FIIs is that the yields in India have also gone up in tandem. FII allocation to Indian bonds is dependent on the yield differential between US benchmark and Indian benchmark. We saw in 2013 when the spread narrowed, there was an outflow of nearly $13 billion from Indian bonds leading to the INR crashing closer to the 69/$ mark. That is surely a situation the RBI would want to avoid.