Is an interest rate cut on the horizon

The questions on everybody's lips are: When will the RBI cut rates And when will banks pass on RBI's previous rate cuts to customers The logic behind those questions is evident. The short-term economic forecasts are not very encouraging. The Reserve Bank of India (RBI) expects the country's GDP to grow at 7.1 per cent in 2016-17, a sharp half percentage point lower than its previous growth estimate of 7.6 per cent. This contraction in growth estimates is mainly because the government's demonetisation initiative has led to a temporary cash crunch that has shrunk economic activity across both the formal and the informal economy. Economists estimate that India has to grow at over 8 per cent per annum for the Modi government to be able to fulfil its promise of delivering achcche din (good times) to the electorate. But even prior to demonetisation, industry and many independent analysts had been clamouring for a repo rate cut by the RBI to lower the cost of money to spur fresh investments, consumption and growth. The central bank, however, disappointed the markets by keeping its repo rate (which banks use as a benchmark for setting their lending and deposit rates) unchanged at 6.25 per cent in its December 7 monetary policy announcement in order to keep inflation in check. “The decision of the Monetary Policy Committee is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth," the RBI said shortly after releasing the policy. The central bank was worried about the recent rise in crude prices pushing inflation in India beyond its 5 per cent comfort band despite admitting that demonetisation and the consequent shrinking of demand will temper the retail inflation figure by 10-15 basis points (bps; 100 bps = 1 percentage point). Many analysts feel the RBI has been behind the curve on cutting rates. Given that banks are suddenly flush with liquidity following the rush to deposit old currency notes, they may lower lending rates a senior economist at a large Indian bank said: “A 10-15 bps cut in lending rates will only be cosmetic change. We need to lower lending rates by at least 100 bps for the consumption demand and investment to pick up significantly.” Will the RBI and the banks oblige They have to look out for not one but 800 pound gorillas in the room before they can. The RBI has to bear in mind US Federal Reserve chief Janet Yellen's statement on interest rates rising in the US. This could lead to an outflow of dollars from emerging economies, including India. India's central bank may be forced to keep rates unchanged to avert such a possibility. Then, commercial banks, which are facing a mountain of bad debts (called non-performing assets or NPAs in banking lingo) have so far been unable to pass on the full benefit of RBI's rate cuts during 2016 because they have to make provisions for their NPAs. How RBI and the banks square these two circles will determine the direction of interest rates in 2017.