RBI may go for interest rate cut under government pressure

Next monetary policy revision is on the door step. Like people waiting for monsoon after a heavy drought, the industry and business people are praying for the end of the current high interest rate regime. Prevailing economic environment is also conducive to enforce the desirable rate cut. On the liquidity front, the RBI has already supplied enough liquidity through last two CRR cut interventions. Hence there is high probability for introducing a repo cut tomorrow without touching the CRR.

                During the last two monetary policy revisions, the RBI was concentrating on financial stability by ensuring enough liquidity in the system. The central bank has reduced the CRR by 125 basis points releasing nearly 80000 crores rupees into the system. Significantly, the double strike with CRR has withdrawn pressure on the central bank’s repo window. Now, the question is whether the RBI is responsible enough to release pressure from the real economy by reducing the interest rate.

                There are three indicators to watch for the RBI to decide on interest policy changes. The first indeed is the level of inflation. Inflation is coming down now. But still, the rate is above that of the RBI’s comfortable rate of 5%. Hence, the RBI has every reason to adopt an unchanged repo rate if inflation is the main factor. Besides, the RBI is always adamant on its set March end target inflation.

                The second factor is the declining performance of the manufacturing sector. Finance ministry is unhappy about continuing high interest rate which is responsible for depressing investment. Already, below par performance of the economy has lead to low tax revenue realizations. Hence, the finance ministry may take a tough stand and this will compel the RBI to work for cutting repo rate.

                Thirdly, liquidity scenario is relatively comfortable now, and can be managed with daily repo actions. The situation doesn’t necessitate further liquidity injection. Similarly, the call money market rate is between 8 to 8.5%, which can be rated normal to a March end situation. On the RBI’s repo window, it is not overburdened as the repo injection has came down to nearly 1.3 lakh crore daily compared to the upper circuit level of around 2 lakh crores couple of weeks ago. Hence, it is not urgent for the RBI to make a CRR cut.

                In conclusion, the situation indicates that the RBI may adopt an interest rate cut strategy by reducing the repo rate. The repo reduction will automatically bring down reverse repo, marginal standing facility and bank rate as well.