MPC decision on interest rate today: Six reasons why RBI should keep status quo on repo rate

The Reserve Bank of India (RBI) will unveil its fourth bi-monthly monetary policy statement on Wednesday. In the last policy in August, it cut the repo rate, the rate at which banks borrows from RBI, by 25 basis points to 6 per cent. Six reasons why RBI should keep a status quo in the current policy.

i)    The Retail Inflation is up
The consumer price index (CPI), which the RBI tracks for adjusting its repo rate, has been hardening  after touching a low of 1.54 per cent in June this year. CPI moved up to 2.4 per cent in July  and 3.36 per cent in August this year. Clearly, the short term trend indicates some hardening in line with the RBI's projection of 3.5-4.5 per cent in the second half (October to March ) of 2017-18. The entire year target for CPI is 4 per cent with plus and minus 2 per cent in 2017-18. There are two more reviews left in December and February to adjust the rates.  

ii)    Higher current account deficit
The current account deficit (CAD), which has been on the decline from 4.8 per cent of GDP in 2012-13 to a low of 0.7 per cent in 2016-17, is suddenly reversing. In the first quarter (April-June) of 2017-18, the CAD has widened to a high of 2.4 per cent of GDP, which is alarming. This is on the back of higher imports of gold and crude in value terms. Given the huge trade deficit  and the sudden outflow of portfolio investments from equity markets, there is every possibility of higher CAD in 2017-18.  This will have a direct impact on the rupee value against the US dollar. The market saw  how the rupee depreciated when the CAD was over 4 per cent between 2011/12 to 2012/13. And if the currency depreciates, there is a threat of imported inflation via  currency in the coming months.

iii)    Likely stimulus to widen fiscal deficit
The fiscal deficit has been steadily declining over the last 5 years from a high of close to 6 per cent in 2012-13  to 3.2 per cent targeted in 2017-18.  The present BJP led NDA government has also adhered to  the road map of keeping a low fiscal deficit. The target for next year -- 2018/19 -- is 3 per cent. The sudden talk of fiscal stimulus to push the country's GDP, which has  crashed to 5.1 per cent  in the first quarter (April-June) of 2017-18, has the potential to impact the fiscal deficit numbers if the matching revenues through tax and non tax is not generated. The RBI would certainly wait and watch for the government moves in this direction before further easing the interest rates now.  

iv)   US Fed rate to move up further
The US Fed rate , which kept is short term rates near zero level for almost seven years, started hiking the rates from 2016 onwards. In a short period of 18 months, the Fed rates have gone up from near zero to 1.25-1.50 per cent.  There is likelihood of another rate hike of 25 basis points before December this year.  The gradual hiking of rate by US Fed is narrowing the interest rates  differential  for investors.  The RBI  will  have to take into account the US Fed rates , which would surely move  up in the coming months.

v)    Banks balance sheet issue still to be resolved
The banks clean up exercise has taken a heavy toll of banks especially the public sector banks, which control over 70 per cent of deposits and advances of the industry. The additional provisioning requirement  for stressed assets especially telecom etc, rising NPAs and also bankruptcy proceedings (where banks have to take major haircuts) has been impacting the profitability of banks. Half a dozen  PSU banks  are already under RBI  monitored  preventive corrective action (PCA) framework because of low capital and profitability issues. Most of the PSU banks  won't be in a position to transmit any rate cuts at this moment because they will tend to protect their margins.

vi)    Over-leveraged corporate and low capacity utilization
The corporate sector itself is over-leveraged with many sectors sitting on over-capacity. The capacity utilization has to move up for further expansion or demand for credit. Similarly, there are many corporate houses that are on a de-leveraging mode, and don't require credit for new projects. These two issues have to settle before corporate would start borrowing from banks. As per available  statistics, the credit growth of banks have fallen to single digit in the last four years. In the first quarter, the credit growth was negative at 2 .22 per cent. So assuming the RBI cuts rates  and banks also transmit the same instantly, there is actually no demand from India Inc.