Repo rate likely to drop first time since April ’12

Tags: Banking

Government’s recent efforts to lift economy trigger move

The Reserve Bank of India (RBI) is expected to reward the government next week for its efforts to reform the economy and bring its finances under control by announcing its first cut in interest rates in nine months.

RBI has been growing in confidence that the government, gripped by inertia for much of last year, is finally doing its bit to lift an economy that has slumped to its slowest pace of growth in a decade.

“The government has gone ahead with all the promises it had made three to four months earlier. There have been pretty substantial measures on the fiscal deficit front,” said Samiran Chakrabarty, head of research at Standard Chartered Bank in Mumbai.

To an extent, that will be comforting for RBI.

Inflation is also heading in the right direction as far as the central bank is concerned. Wholesale price inflation, the main price gauge, fell to a three-year low of just over 7 per cent in December.

Since mid-December, yields on 10-year government bonds have pulled back to 7.86 per cent, from above 8 per cent, in anticipation of a rate cut. The slide marked the first time the yield had dropped below 8 per cent since early 2011.

However, RBI remains cautious with inflation around 7 per cent. Last week, governor Duvvuri Subbarao said inflation remained too high, a comment that dashed financial market expectations for a more aggressive rate cut of 50 basis points.

Most economists expect the central bank to cut its policy repo rate by 25 basis points on Tuesday to 7.75 per cent and follow it up with a cumulative 75 bps of cuts by the end of September, a Reuters poll showed last week.

“RBI cannot be very aggressive in rate cuts. Our view is that inflation is unlikely to fall sustainably below 7 per cent. There are lot of suppressed inflationary pressures that will add to it,” said Sonal Varma, India economist at Nomura in Mumbai.

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