RBI is widely expected to cut the repo rate by 25bps in its policy review on the 29th of January 2013. The rate cut will be the first in calendar 2013 and the second in nine months after its last rate cut in the April 2012 policy where it cut rates by 50bps. RBI had guided markets for rate cuts in January 2013 in its December 2012 policy review.
RBI is more likely to cut the repo rate by 50bps rather than the 25bps cut expected by the markets. The reason for a 50bps cut by the RBI is the positives of the fiscal consolidation measures adopted by the government. The government recently allowed oil companies to raise prices of diesel to reduce their under recoveries and this move is expected to bring down the subsidy bill of the government by 50% in 2013-14. The government is also committing itself to lowering the fiscal deficit in 2013-14 by lowering expenditure and increasing tax revenues. The government is likely to project a fiscal deficit of below 5% of GDP in the 2013-14 budget in February 2013.
RBI firmly believes that high fiscal deficits (5.9% of GDP in 2010-11 and 5.3% of GDP in 2012-13) is a major reason for rising inflation expectations. WPI (Wholesale Price Inflation) Inflation was trending at over 9% levels in 2011 before coming off to 7.25% levels in 2012. High fiscal deficit was seen as a major contributor to high inflation in the economy.
The rise in administered prices of fuel will result in pushing up prices in the economy in the near future. However once the pass through of global oil prices into the economy is complete, the dynamics of inflation expectations will change. Inflation will then be directly correlated to the behavior of oil prices globally and all reports on global oil prices indicate stability and not sharply rising prices as US is expected to import less and less of oil in the coming years.
RBI will choose to look at the longer term benefits of fiscal consolidation through higher prices of administered items such as fuel than the shorter term effects of higher prices in the economy. RBI will be well supported by weak economic data if it cuts the repo rate by 50bps. IIP (Index of Industrial Production) growth is just 1% in the April-November 2012 period while forecasts for automobile sales have been revised to almost 0% levels by the industry body. Export growth is down 5.5% in the April-December 2012 period indicating the weakness in global economies. India’s GDP growth is forecast at 5.8% for fiscal 2012-13 against growth levels of 6.5% seen in 2011-12 and 8.4% seen in 2010-11.
RBI has been putting off rate cuts after the repo rate cut of 50bps in April 2012 on the back of worries of poor government policies on fiscal consolidation and suppressed inflation in the economy due to fuel subsidies. Inflation has been in the 7.2% to 8% range in 2012 and has refused to come off despite sharp slowdown in growth. The fact that the government is trying to address RBI’s worries is positive for rate cut expectations. RBI will cite the need to sustain economic growth that will suffer in the short term on the lack of government spending as the government looks to bring down its deficit.
RBI will reinforce its qualitative growth objective (growth sans inflationary pressures) by cutting rates by 50bps and telling the government that it is appreciative of its efforts on fiscal consolidation. RBI will also tell the government to continue its efforts on bring down subsidies and other wasteful expenditure and that the central bank will then help the cause by easing policy rates further.
Markets will do well to position for a 50bps cut on the 29th of January 2013.