RBI unlikely to cut rate at Aug 4 policy meet, feel experts :Moneycontrol

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Commodity prices continue to stay weak and monsoon has been better than expected. Yet, these factors may still not be good enough to induce the Reserve Bank of India to cut policy rates when it meets on Tuesday to review the monetary policy. 

“Core inflation will be a source of concern to the RBI," says Sajjid Chinoy, Chief Economist at JP Morgan India, adding "because what it suggests, even though any cyclical recovery is modest, along with that recovery we are seeing pricing power picking up."

Neeraj Gambhir, Co-Head Fixed Income at Nomura, says: "Broadly, while the inflation risks seem to have receded a little bit, there is still the major event of Fed which needs to be watched for." 

However, Dr. Pronab Sen Chairman at Statistics Commission says there is "scope to cut rates currently."

Pradeep Kumar, MD of State Bank of India says even if base rate cut happens in August meeting, other economic factors are needed to boost corporate credit flow and improve non-performing loans (NPLs) sitaution. 

“Reserve Bank will be in a position to take a much better view of the situation in September-October when there is clarity about Fed rate increase, about monsoon and sustainability in the oil prices at the lower levels for some time,”
Gambhir adds. 

Below is the transcript of Pronab Sen, Sajjid Chinoy, Neeraj Gambhir & Pradeep Kumar's interview with Latha Venkatesh on CNBC-TV18.

Q: In the previous policy the Governor had raised the inflation forecast for 2016 on the ground that crude prices had risen as well that the monsoon is likely to be dicey this time. Now, at the end of two months, we know that crude prices are back to their near term lows - they are at near five year lows as well the monsoon is not as bad as the Met had forecast. It is probably only 3 percent deficient as of now. Do you think there is a good case to bring down the inflation forecast?

Chinoy: You are right. The previous inflation rates have receded both for domestic and external factors. You spoke about the monsoon being better than expected. We have done some empirical work to suggest that unless the deficiency is 15 percent and more, there is no historical impact of the deficient monsoon or food inflation. 

We are very far away from that threshold. Globally, not only oil prices abated but global food prices have also come down, but the link is that exists between global food prices and India's food inflation. So you are right.

So whether they formally move that forecast down or not could well be tactical but the Reserve Bank of India (RBI) stays on hold for now. But with the inflation risk coming down domestically and externally, the likelihood of the risk of some easing down the line has certainly gone up. 

Q: Is there a case in the first place for even bringing down the inflation forecast?

Sen: I think there is. In fact, I was little surprised when the Governor said that he was upping the inflation forecast for next year because the underlying conditions of the food economy, the agri economy in particular are such that even if the rainfall is deficient, inflation is unlikely to go high except possibly in certain kinds of crops, which leaves the issue of oil prices. As far as oil prices are concerned, I do not see much logic in trying to second guess that. There has been so much volatility, it is so susceptible. 

Q: It is necessary to estimate it and to give it a figure?

Sen: It is necessary to take a call on it but it is also equally necessary to ask yourself the question that can you or should you do anything about it or should you for the moment assume business as usual and then ask the question what are the rest of the prices doing. 

Q: Your take would be that since you began by saying you were surprised that the Governor even raised the forecast in the previous round. You think there is scope to cut rates right now?

Sen: Yes, I do. I think there is fairly substantial scope to cut rates. At the moment as Sajjid rightly pointed out, global food prices are weak and the monsoon is decent. There is going to be some crops, which are going to be affected. 

Onions have already shown some stray, but by and large I see no real risk of inflation over the next five-six months. I think rate cut would be on the card. It can be reversed later if things turn back.

Q: Just to complete this argument, we nevertheless saw food prices and inflation in general come above market expectations for the latest month for June. So, does that deter the reserve bank from going ahead with a cut?

Chinoy: So, the glass is half empty and half full. I agree that in the last three four weeks in particular, inflation risks have receded for the reasons we mentioned, but if you just look at the last June Consumer Price Index (CPI) print and strip away all the noise, what essentially see is underlying inflation - core inflation measured in different ways has stabilized somewhere between 5.5 and 5.7. In fact, the momentum over the last three months has actually increased. 

This will be a source of concern to the RBI because what it suggests is even though any cyclical recovery is modest, along with that recovery we are seeing pricing power picking up. Now of course this could all change if you tell me input costs are going to go down substantially because oil prices are down, then maybe pricing power doesn’t have to rise in tandem with growth but the fact that core inflation has picked up the last three months, underlying inflation is at 5.5 and let’s not forget the big elephant in the room - the Fed.

We are substantially more insulated from global shocks, our current account has collapsed but the RBI would still want to see how disorderly or orderly any Fed exit is going to be in September, which is why I think they will stay on hold next week, perhaps flag that risks have come down but only pull the trigger in September once they are sure that the monsoon was normal and any Fed liftoff has not been disorderly.

Q: Would you buy that?

Gambhir: I will agree with Sajid’s views. Broadly, while the inflation risks seem to have receded a little bit, there is still the major event of Fed which needs to be watched for. There is obviously monsoons which is-we have seen half the period of monsoons get over, there is so far no cause of concern but the rest of the half is equally important, so my guess is that the reserve bank would like to wait to see how the full period of monsoon plays out.

There is some report of sporadic increase in prices, for example in onions where there is a-probably it is a one-off event, but there is some increase in prices. There are those tendencies of volatility in food prices which need to be watched carefully.

I would think that in general, reserve banks will be in a position to take a much better view of the situation somewhere closer to September-October when there is clarity about Fed rate increase, there is clarity about monsoon situation and you have seen sustainability in the oil prices at the lower levels for some time for them to be able to take a much more measured call though our house view currently is that the reserve bank stays on hold for rest of this year.

_PAGRBREAK_

Q: Now the question that is material to citizens, do you think a reserve bank rate cut is all that necessary at this juncture for banks to move their hand and the second part of the question, there is not much credit off-take. Is there anyway scope for banks to make money cheaper for both depositors and for borrowers?

Kumar: If you see our bank’s policy, we have been consistently reducing the deposit rates and we have also decreased our base rates. If we have to decrease our deposit rate further, we are afraid the deposit growth will be hit very badly because the competing instruments like the small savings of the government are paying much higher. 

So, if the government is very serious of bringing down interest rates, they have to seriously look at bringing down the small savings rate. Without decreasing small savings rate, it will be difficult for banks to cut further deposit rates as of now. 

Q: So irrespective of what the RBI does then, you position becomes the same that it is not going to be-let us assume there is a rate cut, even then it will be difficult for you to drop rates according to your argument?

Kumar: Yes, because if you see over the last time when RBI was raising rates when they raised rates by 75 basis points over a six or nine month period, the SBI’s base rates increased by 30 bps and the same thing has happened. Now, when the repo rates have come down by 75 bps, we have brought down the base rate by about 30 bps. 

We can relook at this if we are able to bring down our cost of funds. Our cost of funds in India is primarily cost of deposits and we have been trying to push it down. In SBI, our cost of deposit for the one year bracket which gives the maximum deposits for the banking system in the country is the lowest. 

We are constrained by the small savings rate. If the small savings rate comes down, we will be in a position to have a relook at the deposit rate and if we are able to bring down our cost of deposits, we will be able to certainly bring down the base rates also.

Q: Small savings have their problems as well; they are not as liquid as a fixed deposit. As well in the past, we have seen bank deposit rates fall below small savings rates on several occasions. Since your credit off take is so low, what is your assessment of the way in which deposits and lending rates will proceed in the rest of the year? Do you think there is going to be any further cuts at all to deposit and to base rates in 2015?

Kumar: I believe that if the monsoon is good and the inflation expectations reign, we can expect a cut from the RBI and if not immediately at least in the October policy. The banks will have to relook at credit off take - is not very good, is there is no expectation of a credit off take, we will have to look at our funding cost and we have to reduce our funding cost. So, banks will have a relook maybe sometime in October.

Q: So, as of now if the RBI does not move, you are not seeing any move till October?

Kumar: At least in SBI, I don’t think we see a move till October because recently early part of this month also we have cut down deposit rates.

Q: Will not a cut in interest rates both by the RBI and by the banks somewhat ease the non performing loan (NPL) position. There are a substantial number of people whose interests are latched on to the base rate. If the base rate were to fall by 30 bps, do you think that some more people will have a little more money and therefore will be able to save themselves from falling into the default category?

Kumar: I do agree that if there is a cut in the base rate, the interest cost of everybody will come down whether retail borrower or small and medium enterprise (SME) borrower or a large borrower, but whether that save in interest rate will lead to the account not becoming NPL is a moot point. 
It will be very difficult for me to make a guess. Yes, pressure will come down undoubtedly if the interest rate comes down but whether it will have effect on the NPLs is a moot point because only interest rate doesn't affect NPL. I think the general economy pickup is more essential for the NPLs to come down. 

Q: What about credit off take? At the moment, it is dismal. With a cut in rates, say 25 bps both from the central bank and from you, from the bankers. Is there a chance that credit will pick up or do you think there are still other factors trimming credit off take?

Kumar: There are so many other factors. I do not think there is any large project which is in the offing. If you see the credit off take of large banks, it is primarily project loan, which have driven the credit off take in the corporate sector. The demand for project loan is very low - the pipeline is very thin. Yes, a base rate cut may give a small boost to retail credit, but I do not think it will be a big boost to the corporate credit. Corporate credit will pick up only when the economy picks up and there are projects in pipeline. 

_PAGRBREAK_ 

Q: Do you think that the monetary policy may have something else on NPLs since it is becoming too serious a problem especially with the steel sector. Do you think some special dispensations; packages may at least be flagged off because the ordinary course of growth may not solve the NPL problem according to some experts? 

Kumar: From the RBI's viewpoint, I do not think any special package for any sector is likely to come. It is difficult for me to guess what other measures will come because RBI's view is that interest rates are not the only way to drive growth in business. 

There has to be the fiscal incentives and other government policies which will have to drive growth in business and consequently corporate credit. I do not expect any great announcements in the credit policy in tackling of NPLs.

Q: Let's wind up the discussion on inflation - considering that the RBI's ultimate goal is 4 percent and that 6 percent goal is as of January 2016. Now in July would not the RBI start thinking about its medium-term 4 percent goal. So do you think there will be any hints about that medium-term goal and therefore, what are the expectations in terms of interest rate cuts or interest rate policy from now to the next 12 months? What are you expecting from the RBI?

Chinoy: It is not secret. The RBI has said that starting 2016, monetary policy will be conditioned to gradually disinflate towards 4 percent target over the next two years. I do not think this is going to be where they are going to have massive demand compression to exactly hit for. 

I think the idea is to gradually do that and stay close to 4 because you do have this band of 4 plus or minus 2. My sense therefore has always been that even though global supply shocks can open up the space for some easing given where we are going in the medium-term, this is going to be modest. 

At best, we are penciling in one more rate cut by the end of the year. I think inflation, especially when growth picks up, will stabilise somewhere around 5.5 percent mark over the next 12 months. 

The Governor has spoken about wanting to keep the policy rate somewhere between 1.5-2 percent. I think we will be at the lower end of the band over the next year or so. So I think realistically expect one cut to know more given that we are still on this glide path to disinflation over the next three years.

Q: A year from now the RBI's goal is 4 percent inflation. Do you think there is much wriggled room? How many rate cuts seriously can one expect from now to the next 12-18 months?

Sen: I think the RBI is in a difficult spot. Their figures are showing that capacity utilisation is trending down, the Purchasing Managers’ Index (PMI) has come out looking rather uncomfortable and if you are looking down the road then you have to ask a question - what is going to make this trend move back upwards again. 

I think the effect of the new government taking over is starting to wear off a bit and so it is a moot question whether or not RBI feels that the onus even for turning things around over the medium-term should be borne by fiscal policy and his monetary policy should be strictly aimed towards attaining 4 percent target. Not a very happy position for the Governor, I am afraid.

Q: Are you saying that he should not have had that policy in the first place?

Sen: Having the policy is fine. The point is you have to look at both situations - what's happening on the inflation front and the risk to inflation and also to look at what is the output gap and the output gap is trending upwards. 

Q: So your position that the RBI should have given itself both goals and an inflation targeting goal itself is something it should not have given itself and that it has worked itself in a corner?

Sen: Inflation targeting users of the output gap as well. The tailor rule is clear in terms of what it looks at.

Q: So you are saying that the RBI is faced with a contradiction with inflation not coming down but the output gap remaining high and therefore it is in a corner?

Sen: That's right.