RBI should use the lower than expected June inflation numbers to cut the repo rate by 50bps in its 31st July 2012 policy review. If RBI waits for further conformation of inflation trending down and growth coming off, it will be forced to cut rates by wider margins in its policy reviews in September and October 2012.
Knee jerk rate cuts send out wrong signals to the markets as seen by the effect of unexpected rate cuts on China. Chinese equities are down over 8.5% from highs seen in April 2012 despite two rate cuts by the PBOC (Peoples Bank of China) in the last couple of months. Markets are speculating on a hard landing in China given the urgency with which the rates were cut.
RBI should avoid knee jerk reaction to either inflation or economic data down the line and cut rates in July to keep the policy stance in line with weakening economic growth. The fact that Indian equities and bond prices are trading at close to highs seen since April 2012 suggest that markets are more confident of the RBI handling the current economic situation well. The 50bps rate cut effected in April 2012 and status quo on rates in June 2012 has shown that RBI is keeping its easy monetary stance without giving in to market expectations. Markets were expecting a 25bps rate cut in June.
Markets are ambivalent on rate cuts in July 2012 with expectations ranging from no rate cuts to 25bps rate cuts. Bond markets are factoring in rate cuts without giving undue attention to timing. Five year OIS (Overnight Index Swaps) levels at below 7% is at ten month lows while bond yields are trading at close to fourteen month lows.
RBI by cutting the repo rate by 50bps in July can buy time to reflect on data coming out of India and across the globe. The fact that central banks are cutting rates to record lows globally suggests anxiety on economic growth by central bank chiefs. Eurozone debt crisis and China hard landing are on top of the worry levels of central bankers. The most recent unexpected rate cut came from Bank of Korea, which cut rates in July 2012, well ahead of expectations.
Economic data positive for rate cuts
Inflation as measured by the WPI (Wholesale Price Index) came in at 7.25% for June 2012 against expectations of 7.6%. Inflation fell despite higher food prices. Manufacturing inflation stayed flat at close to 5% levels.
The IIP (Index of Industrial Production) growth for the month of May 2012 came in at 2.4% on a year on year basis against a revised growth of -0.9% for April 2012. Manufacturing growth for May was at 2.5% against a revised growth rate of -1.2% for April. IIP growth and manufacturing growth for May 2011 was at 6.2% and 6.3% year on year respectively. IIP numbers point to decreased industrial activity despite question marks on the quality of data.
India’s exports and imports for May 2012 slowed down by 14.6% and 11.8% respectively on a month on month basis. Trade deficit fell by 6%. Growth slowdown across the globe from China to the Eurozone will impact India’s trade prospects.
Vehicles sales grew in single digit levels for June 2012 with passenger car sales growing at 8.3% year on year and total vehicles sales including two wheelers and commercial vehicles growing at 9.05%. Commercial vehicle sales grew at below 5% for June and the weak growth number implies weak industrial activity.
Bank credit and deposit growth was at 16.5% and 13.4% on a year on year basis as of June 2012. Banks are facing issues of liquidity that is in deficit, assets that are being impaired due to economic slowdown and sticky interest rates due to RBI being cautious on monetary easing.
Gross direct and indirect tax collections grew by 6.8% and 13.8% on a year on year basis in the April-June 2012 period. Tax collections while growing are still weak and below full year growth targets set by the government.