Markets will have a scenario where RBI cuts the repo rate to bring down borrowing costs across the system despite high oil prices.
The sharp rise in oil prices over the last couple of months is worrying markets, central bankers and politicians. Markets are worried that central banks will not cut rates on worries of inflation, central bankers are worried that their efforts to prop up growth or bring down inflation as the case may be will be thwarted while politicians are worried about the price effect on the voting class. Oil prices have gone up by close to 15% over the last two months on the back of geo political tensions in Iran and on the back of better economic growth prospects across the globe due to a flood of liquidity released by central banks.
Brent crude is trading at close to three year highs at USD 123/bbl and given the current tensions going on in Iran, prices are likely to stay high. RBI is going into its 15th March policy review on the back of rising oil prices, tight liquidity conditions, slowing GDP growth and inflation that is at over two year lows. The question is will the RBI cut the repo rate along with the CRR (Cash Reserve Ratio) on the 15th of March?
RBI will have to look at high oil prices as a threat to growth rather than as a threat to inflation. GDP growth from the third quarter of 2011-12 printed at 6.1%, the lowest in three years and down from levels of 7.7% and 6.9% seen in the first and second quarter of 2011-12 respectively. GDP growth is likely to fall below 7% this year if the trend continues. Growth has been impacted by high inflation, which has been trending at over 9% levels for the most of calendar 2011, rising interest rates on the back of RBI policy tightening and on the back of tight liquidity conditions and a fall in global economic growth due to the Eurozone debt crisis. RBI has tightened policy rates by 350bps over the last two years while liquidity has consistently been in a deficit mode over the same period. The IMF has revised global economic growth for 2012 by 75ps on the back of recession worries in the Eurozone.
High oil prices will hurt India badly at this juncture. The country is coming out of a period of high inflation, high interest rates and falling growth and if this trend continues on the back of rising oil prices, it will lead to a sharper fall in growth leading to a spiraling downward growth trend. Indian cannot have a year where interest rates and oil prices threaten growth.
RBI is at a juncture where it will have to give more weight to economic growth. The environment is growth negative with global economy looking weak, domestic liquidity extremely tight with banks borrowing close to Rs 200,000 crores from the RBI on a daily basis and government finances preventing any further stimulus. The government will go into budget 2012-13 looking to bring down spending and bring down fiscal deficit as the deficit for 2011-12 has overshot budget estimates by 1%.
