RBI last cut repo rate in April 2012, where the repo rate was cut by 50bps. RBI will cut repo rate by 50bps on the 30th of October 2012 even as it revises GDP growth estimates from 6.5% to 6%. RBI will state that rate cuts are necessary to keep GDP growth at reasonable levels and not let growth fall off the cliff. Bond markets, especially government bond markets will react positively to rate cuts leading to a 25bps fall in yields.
The RBI policy review meet on the 30th of October 2012 has a divided market on expectations from the policy. There are expectations of a 25bps Repo rate cut and there are expectations of a 25bps CRR (Cash Reserve Ratio) cut. A small section of the market is expecting a 50bps Repo rate cut. What will the RBI deliver to the markets?
The bond market positioning going into the policy suggest that the market expects a rate cut and will be indifferent if it is a Repo rate cut or a CRR cut. The benchmark ten year bond the 8.15% 2022 bond yield closed flat week on week at 8.13% levels indicating that the market is comfortable at current levels of yields and there has been no aggressive bullish or bearish positioning. The yield on the 8.15% 2022 bond has fallen by around 5bps since the last policy review in mid September 2012 on mild rate cut expectations.
The OIS and Corporate Bond yield curve suggest that RBI could be more aggressive on rate cuts. The five year OIS yield at 7% levels is around 107 bps below the five year government bond yield. The high spread indicates that the OIS market is front running a weak economy and subsequent monetary easing. Corporate bond yields at around 8.90% levels for the five and ten year AAA rated bonds are down by 30bps over the last two months leading to credit spreads compressing by around 30bps and 20bps respectively. Falling credit spreads indicate expectations of lower interest rates and higher liquidity.
The case for a CRR cut is due to tightening of liquidity over the last two months. Â Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) of the RBI, averaged Rs 85,000 crores on a daily basis last week. Liquidity deficit has increased by around Rs 40,000 crores over the last couple of months, despite a 25bps CRR cut effected in September 2012 policy review.Monetary aggregates point to weak credit and deposit growth and falling money supply growth. Credit growth at 15.9% on a year on year basis as of 5th October 2010 is down from levels of 16.9% growth seen in end August 2012. Deposit growth at 13.9% year on year is down from 14.7% levels seen in end August. Broad money supply (M3) growth has come off from 13.7% growth seen in end August to 13.3% growth as of 5th October.
The domestic and global economy is exhibiting weakness with Indias GDP growth forecast for 2012 being revised downwards by various think tanks. The IMF has projected an extremely pessimistic growth forecast of 4.9% for India against other forecasts of 5.5% to 6%. IMF has cut global GDP growth for 2012 as well as 2013 indicating the pessimism in economies from China to Brazil.
RBI will take both domestic and global factors into consideration when taking a policy decision on the 30th of October. Slowing monetary aggregates, tight liquidity conditions and clear signs of weakening global economy do call for rate cuts. The only factor that is going against rate cuts is inflation. Inflation as measured by the WPI (Wholesale Price Index) came in at 7.81% for the month of September 2012, a calendar year high. Inflation expectations in India are on the higher side rather than on the lower side and this is largely due to a slow pass through of administered prices into the economy.
The Indian Rupee (INR) has given up around 2.8% against the US Dollar (USD) since the beginning of October 2012. The INR at around Rs 53.6 levels is down 10% on a year on year basis though it is up by 6% from lows seen in June 2012. RBI will weigh the effect of its policy actions on the INR. A rate cut can boost growth sentiments leading to more USD inflows and this can pull up the INR and help neutralize a current account deficit that stood at 3.9% of GDP as of end June 2012.