RBI to slash rates regardless of inflation

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India’s deteriorating economic outlook as coronavirus cases skyrocket increased the possibility that, given inflationary pressures, the Central Bank would cut interest rates during its policy review on Thursday i.e. 6th August 2020.    

Approximately two-thirds of economists in a Reuters poll expect the Indian Reserve Bank (RBI) to reduce the repo rate by another 25 basis points (bps) on Aug. 6 to a record low of 3.50 percent, and again next quarter.

“High inflation has added uncertainty to the policy outlook of the Reserve Bank, but given the state of aggregate demand, we anticipate the RBI will continue to ease,” said Rahul Bajoria, Barclays economist who expects a 25-bp reduction.

Annual Retail inflation increased from 5.84% in March in June to 6.09%, thus remained above the 2% to 6% medium-term RBI target.

Recent policies by the RBI have centered on financial stability and the need to foster growth given the price cap.

Late March, the nation was put under one of the world’s most strict lockdowns for more than two months to curb coronavirus spread. In June, the government slowly relaxed restrictions while infections continue to increase.

The poll found that most economists expect the economy to fall 20 percent in the quarter of June against the April projection of a 5.2 percent decline and stay in negative terrain until the quarter of December.

The economy is expected to contract 5.1 percent for the full year 2020/21, which would be its worst result since 1979, a strong contrast to April’s 1.5 percent growth projection.

In addition to rate cuts, Upasna Bharadwaj, an economist at Kotak Mahindra Bank, expects RBI to tackle demand disruptions and financial market dislocations with liquidity and regulatory steps.

RBI will look to expand the policy corridor to 75 bps by encouraging higher-quantity reverse repo,” she said, adding that while they expect a 25-bp rate cut, it may not be successful in the current setting.

Since February, RBI’s repo rate has already decreased by a total of 115 basis points from 6.50 percent, which ran up from 135 basis points in a relaxing period last year to slow growth.

Nonetheless, some economists think it is prudent for the RBI to pause in August before its rate cuts start again once inflation has stabilized.

Growth weakness versus over target inflation, improved indicators and inflation-related worries, would put RBI at a hard time, said Radhika Rao, a DBS economist.

“It is going to be a close call, but the chances for a break are a little higher.”

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