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Analysis: RBI will respond on Oct 30

Malini Bhupta/ 16 Oct 12 | 12:26 PM

So far, it’s been the Reserve Bank of India preaching to the government on getting its house in order. Now, with the government having bitten the bullet of reforms, the pressure on the central bank is immense, because the boot is now on the other foot. Finance minister P Chidambaram has already indicated that rates need to ease for growth to pick up again.

But there’s one little matter that has possibly escaped the FM – inflation. The impact of his reforms has left an indelible print on inflation (Wholesale Price Index), which has inched up to 7.8% for September. Economists believe that WPI will close the December quarter at 8-8.2% levels, which by no stretch of imagination is low. The other measures (read liberalising sectors like aviation, insurance and retail) are unlikely to have any impact on the deficits just yet. 

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Having said that, it’s going to be very difficult for RBI to cold shoulder what the government has done so far and not act. Sometimes it’s important to be seen to be doing something. So from the look of it, the central bank may well want to be seen as reciprocating. The pressure on RBI is immense to act. But that action may not be what the market wants – a rate cut. So what will the central bank’s response be in the face of the government’s reforms rush?

Economists and rate strategists believe that it is a touch and go situation as far as RBI’s rate moves is concerned. However, since WPI has come in at 7.8%, which is higher than the consensus estimate of 7.7% and CPI has remains in the 9-10% range, any rate cut would hit the RBI’s credibility. Morgan Stanley’s Upasana Chachra and Chetan Ahya believe that the policy decision to reduce rates in the next monetary policy review on October 30 will be touch-and-go. They say, “We believe that the macro conditions warrant a delay in policy rate cuts."
The other reason behind RBI’s dilemma would also be higher than expected fiscal and trade deficits. Trade deficit for September widened to $18.08 billion (11.9% of GDP annualised) compared to $15.6 billion in previous month (10.3% of GDP annualised). Clearly, there is little comfort from the fiscal side.

Rohini Malkani believes that other than rate action, there are other measures that the RBI could look at. For starters, it could relax provision norms in certain sectors. It could also reduce risk-weighted assets and tweak priority sector norms. These would have the required impact on sectors that need a boost and yet it would not hurt its credibility.

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