RBI repo rate cut surprises, but not the time to cheer yet

If you believe that the Reserve Bank of India's (RBI) bold move of 50 basis points policy rate cut for the first time in the last three years has marked the beginning of a softer or mouth watering interest rate regime, think again! You are probably celebrating too early.

Economically speaking, there is very limited scope for interest rate relaxation in the 2012-13.

Nomura India's Sonal Varma in her recent report has predicted a shallow rate cutting cycle. "We expect a total of 75 basis points of repo rate cuts in 2012," believes Varma. One basis point is equal to one hundreadth of a per cent.

In fact, the cumulative hikes of over 300 basis points over the past two years will take almost 18 months to two years to unwind.

And for any meaningful decline in lending rates for home and car loans as well as corporate borrowers, it will have to be accompained by cut in the deposits rates, which is not going to happen soon as banks are already struggling with sluggish deposit growth.

Today, a three to 10 year term deposit with State Bank of India (SBI) earns 9.25 per cent per annum.

According to new generation private sector Yes Bank, the cumulative rate cut expectations are of 50-75 basis points in the current financial year. These rate cut projections, take for example, translate into SBI probaby reducing its home loan rates from existing 11 per cent to 10 per cent.This is for the average home loan sizes of Rs 30 lakhs to Rs 75 lakhs. That will hardly be called as relief to hapless borrowers.

So, who is going to spoil the rate cut party?
Clearly, it is too early to write off inflation monster. While the latest March figures of Wholesale Price Index (WPI) inflation have shown marginal downward trend at 6.89 per cent, against 6.95 per cent in February this year, the food inflation (main culprits are cereals, vegetables and milk) has actually pole vaulted from 6.1 per cent to 9.9 per cent in the same period.

This sudden return of food inflation is going to be a big spoilsport.

And so far, nobody has factored in the risk emnating from poor monsoon or the possibility of another round of liquidity boost by the US, ahead of its Presidential election in November this year.

There is also no comfort when one compares the WPI inflation year on year. Despite raising interest rate for two years, the WPI has ended at around 8.8 per cent in 2011-12, against 9.5 per cent in 2010-11. This actually means a decline of less than 100 basis points, which is not a comforting factor for policy makers.

RBI, too, has projected the inflation to remain at 7 per cent 2012-13 from last year's 8.8 per cent because of high fuel prices and recent hike in excise and service taxes.

In the current year , there is also a lurking danger from crude prices. The Brent crude oil prices are still hovering at over $120 a barrel (remember FM Mukherjee has made his Budget assumption at $115 per barrel).

According to experts, if Brent crude prices remains at over $120 a barrel and domestic currency hovers at over 50 a dollar, the retail fuel prices have to move upwards or the oil companies have to bear the burden of additional subsidies.

The state elections in half a dozen states in the next 18 months with general election in early 2014 is going to resrict government from hiking fuel prices in a big way.

There is also not much help from the Union Budget presented last month.

The budgeted reduction in fiscal deficit to 5.1 per cent in 2012-13 doesn't evoke confidence because of last year's slippages from 4.8 per cent to an alarming level of 5.9 per cent. The huge government borrowing at Rs 5.7 lakh crore to bridge the budget deficit, and out of which 3.7 lakh crore to be done by September this year will put pressure on yields and consequently on domestic interest rates.

Similarly, the widening of current account deficit is yet another red spot that will keep an upward bias on interest rates as any fall in deposit rates, would also discourage foreign investors especially NRIs to invest in the Indian markets.

The RBI - which has stabilised the rupee value against dollar a bit because of host of unpopular measures, including deregulating the NRE deposit rates (which is a short term debt) - has all the potential to raise its head. The domestic currency is again looking vulnerable at 51.59 level against the dollar.

Clearly, there is limited room for easing going forward. So, not yet time to cheer.