Easing inflation, tight liquidity and slowing growth should prompt rate cuts
RBI will have to have a very strong reason to tread cautiously on rate cuts. The economy is looking to slow and slow down fast and if RBI does not act quickly the danger of a free fall is not ruled out. Rate cuts work with a lag. Even if RBI starts cutting rates now, the effects will be seen only in the second half of fiscal 2012-13. The longer the RBI holds back rate cuts, the longer the time frame for an uptick in the economy.
Inflation printing at below 7.5% levels, GDP growth forecasts revised downwards to below 7%, tight liquidity conditions, weak credit growth, downbeat corporate sentiments, gloomy global economic forecasts and financial market volatility are the reasons why RBI should cut policy rates of CRR (Cash Reserve Ratio) and Repo by 50bps in its January 24th 2012 policy review.
Inflation as measured by the WPI (Wholesale Price Index) for the month of December 2011 is expected to come in at below 7.5% from 9.13% levels seen in November 2011. Inflation will be at two year lows if it comes in below 7.5%. The fall in inflation for December 2011 is led by fall in primary article inflation (with a 20% weight in the overall index). Primary article inflation has come off from 6.9% in November 2011 to 0.51% in December 2011. Primary article inflation downtrend is led by food inflation, which has come off from 6.6% levels to -2.9% levels. Inflation in all likelihood will breach RBI’s estimate of 7% for March 2012 as the drivers of inflation including credit growth, liquidity and consumption demand are clearly weakening.
Liquidity as measured by the bids for repo in the LAF LAF (Liquidity Adjustment Facility) auction of the RBI is staying above RBI’s comfort levels of 1% of NDTL (Net Demand and Time Liabilities), which is around Rs 60,000 crores. Bids for repo in the LAF averaged Rs 128,000 crores on a daily basis last week up from Rs 96,000 crores seen in the week before last. Liquidity is tightening despite RBI’s infusion of Rs 53,000 crores through bond purchases. There are structural issues affecting liquidity and RBI will have to cut CRR to ease liquidity.
Bank credit growth has come off to 15.9% year on year as of end December 2011. Credit growth is down from 22% levels seen in the beginning of fiscal 2011. Monetary tightening and tight liquidity conditions have impacted credit growth. RBI has raised repo rates by 175bps this fiscal to bring down inflation expectations. Sound bytes from bankers indicate that credit growth is unlikely to take off on the back of worries of non performing loans.
Corporate sentiments are downbeat. Companies such as Bajaj Auto, which were seeing healthy double digit growth in sales of two wheelers until November 2011 despite rising interest rates are now sounding cautious on growth. The company is seeing weakness in rural demand, which is worrying given that rural demand is seen as one of the positive factors for the economy. Infosys the technology bell weather has guided for no growth in the fourth quarter of 2011-12 citing high uncertainty in its main markets of the US and Europe.
Global economic turmoil is continuing with the latest downgrades of credit ratings by S&P of Eurozone countries including France, Austria, Italy and Spain. S&P downgraded the sovereign credit ratings on the 13th of January 2012 citing lack of progress in fiscal consolidating in the Eurozone. Economic growth in the Eurozone is likely to stay flat or even fall into minor recession on the back of austerity measures adopted by Eurozone countries.
Financial markets have had a very poor year in 2011. Equity indices across the globe fell in calendar 2011 on the back of debt issues in the Eurozone and inflation issues in emerging markets. Currency markets are exhibiting high volatility with the Indian Rupee falling by over 15% against the US Dollar in the last one year. The Euro has fallen by over 10% against the USD in the last four months and is likely to fall further post the downgrades. Financial market volatility is likely to continue into 2012 given the issues surrounding India and the world.
The government has sounded out a further revision in GDP growth from 7.5% to below 7% for fiscal 2011-12. GDP growth has been steadily revised downwards from levels of 9% forecast in the budget for 2011-12. The IIP (Index of Industrial Production) growth for the April-November 2011 period at 3.8% is down from 8.4% growth levels seen in 2010-12. Falling credit growth, downbeat corporate sentiments and global economic turmoil all suggest GDP growth slowing down faster than expected.
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