To rate cut or not… I think not!

A 25 bps cut in the repo rate (this is the rate at which the central bank of a country in our case RBI lends to commercial banks in event of a shortfall) is what most the market is factoring in.

 

 

The RBI meets on Tuesday for the bi-monthly policy meet, and it is widely believed that given the reasons that the governor had given for warranting a rate cut are now a reality and this should result in the RBI announcing a cut in this meeting.

 

The consumer price index (CPI) inflation has been trending lower in the recent months. CPI inflation, which stood at 5.4 percent in June, fell to 3.69 percent in July and subsequently 3.66 percent in August.

 

The wholesale price index (WPI) inflation has been in negative territory for more than ten months, the lower crude and commodity prices internationally have had a big hand in getting it there for setting the stage for lower inflation.

 

There are those, and I belong to that camp, who think that there will be no rate cut this meeting. The reasons? Well several. The biggest fear is that inflation could well go up given that we have had a weak monsoon and we don’t know how much it will impact food prices.

 

Globally as a result of the China Yuan devaluation things are in a flux. As and when the US Fed increases interest rates we could see a flight of capital.

 

So far this year we have a 75 bps rates cut but they haven’t resulted in lower interest rates for us! Banks have balance sheets that are severely hit, and corporates have huge existing debts and we cannot expect credit growth to go up any time soon.

 

That said there could be some possible scenarios:

 

RBI takes the plunge and announces a 25 bps cut; in this case the market will watch the commentary.   25 bps is already factored in and if the outlook is dovish then the market could cheer this. A rate cut and a cut in SLR along with a dovish statement is the best-case scenario and we could see a bit of rally.

 

However if the view is one of caution then this could result in some degree of sell-off even if there is a rate cut, as this has already been factored in.

 

The third scenario is one of no rate cut and this will certainly drive markets in the short term and we could see a 3-4% sell-off from current levels.

 

The pressure from North Block is certainly one that cannot be ignored – and which is why the market is largely factoring in a 25 bps cut but my feeling is that they will do nothing in this meeting and will wait for Fed action and internal factors like inflation to play out before they cut rates further.

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