The RBI has left rates on hold since a 50 basis point cut in April, and expectations for a further cut have been pushed from December into the first quarter of 2013 following guidance by the central bank in late October.
The CRR—currently at 4.25 per cent, the lowest since 1976—is the portion of deposits that banks have to mandatorily park with the RBI. There has been some tightening on the liquidity front due to advance tax outgo. Following this, the banks' borrowing from the RBI has gone up to Rs. 1,46,300 crore on Monday from Rs. 64,445 crore on Friday.
RBI Governor Duvvuri Subbarao had said in the October policy review there was a "reasonable likelihood" of further easing in the January-March quarter, when inflation is expected to trend down.
However, industry has been waiting for a change in key rates to help revive flagging growth and Finance Minister P Chidambaram had giving voice to disappointment at the RBI’s stance of reining in inflation before changing key rates after the central bank’s announcement in October. Mr Chidambaram said, “Growth is as much a challenge as inflation. If the government has to walk alone to face the challenge of growth, then we will walk alone.” Mr Chidambaram was referring to the RBI’s stance of reining in inflation before changing key rates.
The RBI governor had said then at a post-policy press conference,“Both the government and the RBI share concerns on growth. Even (the) RBI has concerns about growth and inflation; only, our balance is shifting. If you are asking about the nuances in the Finance Minister’s statement, I think you should ask him.”
Experts say the tight liquidity condition will continue for a while till the government starts spending, and this makes a case for lowering the CRR.
Indian Overseas Bank chairman and managing director M. Narendra said on Monday: "...as on date since liquidity still has been slightly tight, I think there will be some more support to liquidity (through CRR cut). We will not be surprised if there will also be a symbolic repo rate cut now and a major cut in January also."
SBI managing director Diwakar Gupta said RBI should consider cutting both repo rate and the CRR. "As a banker I can always say that our wish list is that rate should change, they should reduce. Both repo and CRR," he said.
The repo rate is the rate at which the RBI lends money to the banks. It stands at 8 per cent at present.
"The CRR has already been brought down significantly by the Reserve Bank, if they do a little more that will be great,” Mr Gupta added. “A cut in the repo rate will actually bring down rate systematically in the system. So, deposits will be cheaper, and therefore people will lend cheaper. Overall, there will be a downward bias which has been required," he added (read).
An unexpected jump in industrial output and lower-than-expected inflation – which declined to a 10-month low of 7.24 per cent in November from 7.45 per cent in the previous month -- has reinforced hopes that the RBI could start cutting interest rates at its policy meet in January. Further traction on reforms is also anticipated as the Winter Session of Parliament is due to end on December 20.
"I don't regard 7-plus per cent inflation as a comfort zone. But the important thing is that if you think it is heading down, then may be the time has come to recognise that inflation is clearly softening and growth is weak and I am sure that the RBI knows what to do," Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, said after the inflation data was announced.
The government has already approved or passed a slew of fiscal and economic reforms. However, Bills on banking, pension and insurance are pending.
Prime Minister Manmohan Singh's government wants Parliament to approve policies aimed at attracting foreign capital into banking, insurance and pensions before a recess this week, along with a Bill to help land acquisitions for industrial and infrastructure projects.
The measures are part of a package of policies the government and business leaders say are needed to stabilise India's economy, which is running high fiscal and external deficits and is on track for the weakest year of growth in a decade, at below 6 per cent.
Goldman Sachs said it expected the RBI to cut its key interest rate by 25 basis points at its policy review on Tuesday after last week's inflation data came well below expectations, and as economic growth remains sluggish.
The investment bank expects another 25 basis point cut in the repo rate in January, according to an email sent to clients on Monday. Goldman had previously forecast the RBI would cut interest rates by 50 basis points in March.
"With both growth and inflation surprising on the downside relative to the RBI's forecast, there is a reason for the central bank to move earlier than its previous guidance," economist Tushar Poddar wrote in the note.
Bank of America Merrill Lynch has reiterated its call of a 25 basis point cut in CRR at today's review.
“In our view, the bigger worry is the rising risk to lending rate cuts with RBI forex intervention pulling deposit growth down to 12.8 per cent well below 16.8 per cent loan demand. As it is, India is the only BRIC in which lending rates are stuck at their 2008 peak. It is for this reason we find RBI CRR cuts/OMO (open market operations) far more essential than repo rate cuts. In any case, RBI policy rate cuts will not likely translate into lending rate cuts till liquidity improves,” BofA-ML says in a note.
British lender Barclays earlier said the RBI is likely to leave the policy rates unchanged at the review tomorrow and that a lending rate cut may happen only in the January policy announcement.
"We believe RBI will continue with its liquidity infusions through CRR cuts and OMOs to take care of liquidity concerns. A repo rate (at which RBI lends to banks) cut is not expected before late January," Barclays said in a note.
Over the past three months, the RBI has reduced the CRR by 50 basis points or 0.50 percentage points to 8 per cent. But these cuts did not lead to an easing of overnight rates.
"Given the prevailing liquidity conditions, we do expect OMO and further CRR cuts in the remaining three months of the fiscal year. The steep fall in GDP growth will likely trigger repo rate cuts in the next quarter," the report said.
Noting that CRR cuts did not lead to easing of lending rates, it said any more CRR cuts will also not ease lending rates. As has been visible in the past months, despite RBI significantly reducing the CRR to the tune of 175 bps to 4.25 per cent in 2012, the lending rate has not come down.
In its mid-year economic review tabled in the Lok Sabha yesterday, the Finance Ministry lowered the economy’s official growth forecast to between 5.7 per cent and 5.9 per cent for this fiscal year, but added that it was on track to meet the fiscal deficit target of 5.3 per cent. The economy is expected to grow by 6 per cent in the second half of the current fiscal year.
The budgeted forecast for gross domestic product (GDP) growth in the 2012-13 fiscal year was 7.6 per cent, but growth was just 5.4 per cent in the first half of the year. Finance Minister P. Chidambaram recently projected growth of between 5.5 and 6 per cent for the year.
A sharp industrial slowdown, less-than-conducive financial markets inhibiting the government’s divestment plans, and continued high subsidy outgo due to high global crude prices are unlikely to reverse substantially over the foreseeable future, according to the review.
Of 41 analysts polled by Reuters, 37 expect the RBI to keep the policy repo rate unchanged at 8 per cent in December.
Respondents were almost evenly divided on expectations for a cut in CRR, a tool the central bank has been using to ease a cash crunch and prod banks to loosen lending rates.
Of the 33 respondents, 16 expect a CRR cut on Tuesday of either 25 or 50 basis points, while most also expect a further CRR cut in the March quarter.
While expectations are near-unanimous for an interest rate cut in the March quarter, 20 of 36 respondents expect 50 basis points of cuts, which is deeper than the 25 basis point expected in the October pre-policy poll. The RBI is expected to review monetary policy in January and again in March.
"Given the fact that growth is in shambles, and inflation is sort of coming under control, I think they will reiterate the guidance this time and say a rate cut is likely in January," Abheek Barua, chief economist with HDFC Bank in New Delhi, told Reuters.
With inputs from agencies