This time is as good as any for the RBI to affect a cut in policy rates

When it comes to monetary policy, it is very rare for a commercial bank to show the way to a central bank. But on Monday, the State Bank of India (SBI) cleared the decks for an imminent rate cut. By cutting the deposit rate on savings bank accounts from 4 per cent to 3.5 per cent for deposits below Rs one crore, SBI has held up a neon sign for the Reserve Bank of India (RBI) that a cut in policy rates is overdue.

The two-day monetary policy committee (MPC) meeting, which started on Monday should end up delivering that cut of at least 25 basis points. This dip in savings bank rate, which is going to be followed by other banks, means there is no dearth of liquidity that has emboldened India’s number one bank to cut the savings rate. But at the same time, for the credit off take to improve, lending rates need to come down by banks and for that to happen, a cut by RBI is the pre-condition.

If RBI is waiting for perfect conditions to cut rates, we probably have the best conditions yet. There are two components, which determine the interest rates, inflation trajectory and economic growth numbers. As far as inflation is concerned, for the last few months, there have been clear indications that along with core inflation numbers, which were a very benign 1.54 per cent for the month of June, all components are well under control.

This means that the real rate of interest, which is an important factor in determining policy rate, stays within the comfortable window of 2 per cent, which had been RBI’s unwritten stand. Even sticky food inflation, despite a one off increase in the price of some vegetables, is clearly under control and even if it spikes toward the end of the year, it will not take the CPI number beyond 4 per cent, which is very well within the limit set by RBI. Till oil prices don’t shoot above the $70 mark and stay there for a considerable period of time, the risk of any spike in inflation in India is very low. Given the fact that OPEC has been struggling to push oil prices above the $50 mark means that the RBI doesn’t have a rising import bill to worry about.

On the other hand, as far as economic growth numbers are concerned, there are clear signs that they are decelerating rapidly and some hand holding is required by the central bank and the government. Core sector numbers declared on Monday were dismal. June core output just grew up by 0.4 per cent year-on- year basis. The more troublesome part of these numbers is continued contraction in cement numbers. It is cement demand, which expands and contracts first before it gets reflected in numbers from other sectors.

At this point of time, if a policy rate cut is announced, banks which have largely made provisions for their NPAs in the last 15 months, are in a far better position to pass on that rate cut within a short span of time as compared to the earlier phase where banks were slow in passing on the benefit to borrowers. Another big reason why a cut at this point of time makes imminent sense is because the rate of recovery of consumer demand, which had been affected first due to demonetisation and then due to GST implementation, will be able to pick up pace faster as the forthcoming festival season demand could bring back growth if interest rates are cut at this point of time.