Rate cut may be symbolic

With the decline in inflation numbers, the pressure is mounting on the Reserve Bank to go in for a rate cut at its September 29 policy meeting or even before. The rate cut lobby has raised its voice, demanding a cut of 75 to 100 bps this time.

It is true, the WPI and the CPI numbers released on Monday offer enough room for the banking regulator to decide on the rate cut this time, but RBI Governor Raghuram Rajan may still hold it because of a sticky food inflation which increased to 2.2 per cent from 2.15 per cent a month ago; also the overall inflation is showing a downward trend.

Even the economists are of the opinion that the food inflation will further increase, considering the deficient monsoon conditions in major parts of India, which are still dependent on rains for irrigation. As per government estimates, the monsoon will be lower this year by at least 14 per cent.

Under these conditions, it is still to be seen how far Rajan can resist the pressures from multiple quarters, be it government or industry. While the government has already prompted a much bigger rate cut –the Finance Minister often indicates a rate cut, and promptly he gets supported from the government economists Arvind Subramanian and Arvind Panagariya who suggest a rate cut of up to 100 basis points.

But, will Rajan oblige them? For instance, there is huge gap between CPI inflation numbers in rural and urban areas. During August, the rural CPI inflation was 4.47 per cent and the urban CPI inflation was 2.67 per cent. The difference between rural and urban areas may further increase. And this is sufficient for the RBI to hold off the rate cut this time.

This apart, the Reserve Bank has to consider the possible US Fed rate hike and its impact on the global economy. Although, Rajan had, time and again, assured the country that India was prepared for US Fed rate hike due to higher forex reserves, but he cannot ignore the US rate hike impact while taking a rate cut decision.

Moreover, the RBI is working out a plan to limit the number of banks in a lending consortium, which will improve recovery and help the banking system to reduce NPAs and improve the health of banks. Of course, there are some macro indicators that are favourable for a rate cut, as most of the banks have already passed on the effect of earlier rate cut.

And there are some positive indications that the economic recovery has started, such as the IIP numbers in July which zoomed to 4.2 per cent. If the trend continues further, Rajan may safely take a call on rate cut without much of hesitation and pressure in order to encourage the industry. Thus, a symbolic rate cut of 25 basis points may be ideal and not a bigger cut, as price worries are still looming large on the economy.