Will Raghuram Rajan Cut Repo Rate Next Week?

Few are as lucky as RBI Governor Raghuram Rajan. Recently, Rajan described India as an island of calm in an ocean of turmoil, hinting at the financial turmoil in China, Canada and the United States (US). But, the man who had predicted the US sub-prime mortgage crisis of 2008, is not easily fooled by favourable numbers.

When he was asked whether the RBI would cut the repo rate for the fourth time this year, his answer was very succinct: His priority is to maintain low levels of inflation. While Rajan promised to adopt an accommodative monetary policy, he added that his decisions will be guided by incoming data.

The August 2015, the consumer price inflation (CPI) was 3.66 per cent and wholesale price inflation fell by 4.95 per cent when compared to the previous year. Though the figures are impressive, the governor is not too swayed by them. The RBI believes that a major reason why CPI inflation is low is because of the base effect. Otherwise, CPI inflation would have been 5.5 percent. The central bank would be closely watching the trend.

Here is what he will weigh before deciding on whether the RBI should cut the repo rate:

Monsoon and food prices

“Developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon, as the Reserve Bank stays vigilant to any threats to the disinflation that is underway,” Rajan said in the August monetary policy statement. According to the weather department, till September 20, 2015, so far, rainfall has been 14 per cent below normal. Moreover, food grain producing areas have received much lesser rainfall than others.

The Federal Reserve's monetary policy

Though India is increasingly becoming independent of global volatility, RBI governor Raghuram Rajan said that the RBI will look for signs of normalisation of the US monetary policy. In September, the Federal Reserve decided to keep the ultra-low interest rate regime of 0.25 percent unchanged. If the Fed had hiked interest rates, Indian stock markets would have seen Foreign Institutional Investor (FII) outflows. It was expected that the Federal Reserve would hike interest rates though it had not raised the rates since 2006.

“This clearly shows uncanny fear of the US Fed of a sudden meltdown in fragile economic conditions. There is a greater acceptance of an extended recovery from the Fed's commentary and figures, with implications for global demand. That doesn't augur well for our recovery too,” said Soumya Kanti Ghosh, Chief Economic Adviser of State Bank of India (SBI), in a report.

As the Fed did not hike interest rates, will Raghuram Rajan cut the repo rate in September's monetary policy review? “Limping global growth coupled with uncertainty about US growth probably compelled US Fed to stay on hold," Rajan said, responding to the Fed move.

Economic growth; fast or sustainable?

The GDP growth numbers too have been painting a favourable picture of India. The Central Statistical Organisation estimated the third quarter growth at 7.5 percent, bringing the annual GDP growth over seven per cent. Yet again, Rajan questioned the authenticity of these numbers because they do not correspond with other data sets.

In the monetary policy review in April, the RBI noted that mixed signals are coming from service sectors. Various indicators of services sector activity including railway and port traffic, domestic and international passenger traffic, international freight traffic, tourist arrivals, motorcycle and tractor sales as well as bank credit and deposit growth remain subdued. The possibility of a positive move would depend on how the central bank perceives how the economy is doing on these parameters.

Rajan does not believe in lowering interest rates to stimulate economic growth. He often points out that countries like Brazil which tried to stimulate growth by lowering interest rates have high inflation and ended up receiving a junk rating by S&P.

Credit/deposit growth

The RBI's agenda is to raise credit growth as well as deposit growth. Credit growth declined to 9.7 per cent from 10 per cent between September 2014 and March 2015. Export credit registered a negative growth of 5.6 per cent. Deposit growth too declined to 10.7 per cent from 12.9 per cent, according to Financial Stability Report, released in June. But, will Rajan cut the repo rate to raise credit and deposit growth? We will have to wait till the end of the month!