Will bank dread the dark clouds or dance with the silver lining?

For many, it may be a foregone conclusion that RBI will cut repo rate this time, but you can always get surprised with no rate cut. Let us look at the hide and seek game played by the clouds and the sun. In its pursuit of the twin objectives of price stability and growth RBI (read MPC) weighs a lot of factors, tangible or intangible, domestic or international, political or geopolitical, monetary or real, liquidity issue versus exchange rate volatility etc.

The seventh CPC verdict on HRA is out and so is the danger of farm loan waiver clearly visible to fit into the inflation forecasting model. I believe the housewives must have been contacted by the surveyors to capture their inflation expectations. The MET data, the spatial distribution of rains, changing cropping patterns and international commodity price movements will be tracked. Someone will be reading the minds of Fed Chair and Secretary General of OPEC. Any one single factor can be enough to hold back the action on the rate cut. However, for the economy to grow, both price stability and growth objective are important and should be achieved with a perfect act of balancing.

If one looks at the published data, the inflation numbers are quite benign and below the lower end of the target range of 2 to 6 per cent. The GDP growth on the other end is not picking up. The Q4FY17 growth of 6.1 per cent is far from encouraging. Lower price inflation clearly shows lack of demand.

There is a need to pump prime the demand – consumption as well as capital goods demand. Consumption demand is also ultimately linked to new investments in core and capital intensive industries. Banks are flush with funds but facing weak credit demand. But are the interest rates high and the sole reason for credit not picking up? The answer is no. Will banks reduce interest rates after the rate cut? The answer is may be but only at the cost of further squeeze on net interest margin. If banks choose to maintain interest margins by realigning the deposit rates downwards, there is a fear of losing the deposit base as already more and more people are choosing alternate investment avenues especially mutual funds.

On balance, a rate cut is desirable from macroeconomic perspective without too much of a threat to price stability. Should the situation warrant, repo rate can be revised anytime by RBI. If the rate cut leads to all the desirable and measurable impact on growth and employment, banks being an important intermediary will stand to gain though in the long run. Taking into account all these elements, I strongly feel that the RBI will certainly dance with the silver lining rather than reading too much into the shifting clouds.