Amidst all the hype of expectations in the market for a rate cut, let us look at some facts: the malady of slowing growth can be better redressed with policy reforms, removing bottlenecks and providing incentives for building capacities, rather than quick rate cuts.
Rate cut can be done anytime in the eight policy review meetings in a year, or in an emergency, even between policy review meetings. It has been mentioned in today's statement as well: slowdown in growth is due to many factors like investment, production capacity creation, etc and the role of rate cuts is relatively small.
When the RBI delivered a more-than-expected 50 bps rate cut on April 17, the accompanying message was clear: the government should do its bit for controlling inflation by fiscal consolidation e.g. contain subsidies at 2 per cent of GDP. Easing crude prices is a positive, but there are significant subsidies in diesel, kerosene and LPG.
It has been re-iterated that the rate cut on April 17 was based on the premise that the process of fiscal consolidation critical for inflation management would get under way. The RBI's view is clear: rate cut(s) at this juncture would lead to inflationary pressures.
On liquidity, though there is no CRR cut as such, export credit refinance would release Rs 30,000 crore into the system and there is a comforting statement that management of liquidity remains a priority and OMOs will continue as and when required.
The target of liquidity tightness in the system remains somewhere around 1 per cent of NDTL i.e. around Rs 60,000 crore of the RBI funding through LAF. Had there been a CRR cut, OMOs would not have been expected in the near term.
The door for rate cuts remains open; it has been mentioned in the statement that in view of the volatile global situation, the RBI "stands ready to use all available instruments and measures to respond rapidly and appropriately to any adverse developments." Clearly, the RBI is keeping its powder dry for future contingencies.
We maintain the view that there could be 25 to 50 bps rate cut in the second half of the year in view of sub-par growth, provided inflation and fiscal consolidation (or the lack of it) is within acceptable limits.
The 10-year (new) benchmark Gilt yield has settled around 8.13% now from 8.02% in the morning (prior to the policy announcement), which is not a very significant bear move, given the strong rate cut expectations in the market prior to the policy review. In the money market, 1-year CD yield has moved up to approx 9.60% - 9.65 per cent from 9.48 per cent on Friday (source Bloomberg). Three-month CD level has reacted more, moving up to approximately 9.3 per cent from 9.1 per cent on Friday. That is to say, market has taken the status quo more-or-less in stride.
Going forward, over a horizon of six to nine months, there is scope for easing in yield levels as and when the RBI takes rate action or infuses liquidity into the system.