Bank of America Merrill Lynch, a financial conglomerate, has said that it saw banks cutting interest rates in the upcoming slack season starting September.
It said, with the RBI keeping its rates on hold as part of its monetary policy review yesterday, chances of a ‘long hold’ of Reserve Bank’s interest rates are now high.
“We grow more confident in our call that the RBI will be on long hold after today’s second consecutive pause. This reinforces our view that banks will cut lending rates
in the slack season ending in September… On our part, we see the RBI on hold until December, to ride out possible El Nino risks. If the El Nino materializes, it will likely cut rates only in early 2015.”
The reason for the banks cutting interest rates has to do with two factors – growth and inflation.
“High rates continue to impede a recovery. Second, CPI inflation is peaking, with May inflation likely to come off to 8.4% from April’s 8.6%,” it said.
“We have long highlighted that high rates are impeding recovery, although we fancy ourselves hawks. After all, the July tightening measures ended up pushing recovery by a year.
“FY14 growth has ended at an anemic 4.7%. April IIP will likely remain flat, at 0%, on June 12, after a decline of 0.5% in March. Although many pin hope on a revival of stalled projects, we continue to point out that these would not be taken up unless rates soften to re-ignite demand. While the worst is over, we continue to argue that recovery will need softer rates.”
It further pointed out that it has a GDP growth rate estimate of 5.4% in the current financial year, but that is contingent on lending rate cuts of 50-75bp and normal rains.
While El Niño risks are rising, the Modi government may prefer to combat agflation with supply side measures, it said.
The Reserve Bank had in its recent commentary said it was committed to keeping the economy on a disinflationary course, “taking CPI inflation to 8% by January 2015
and 6% by January 2016. If the economy stays on this course, further policy tightening will not be warranted.
“On the other hand, if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance…”
Consumer Price inflation, which has been around 10% for the last ten years, is seen declining to 7% levels by March 2015, well below the RBI’s 8% target, according to BoFA ML.
However, an El Niño-induced drought poses a 250-400bp upside risk to CPI inflation, it added.
“Food inflation has already reversed in May and is showing signs of collapsing in June, at both the retail and wholesale levels, due to the bumper rabi harvest,” it added.
BoFA ML expects NDA II government, like NDA I, to emphasize supply management rather than monetary tightening in case of an El Niño.
In NDA-I, RBI Gov Jalan cut CRR/rates during the 2002 drought (Chart 3).
In 2011, pointed out the firm, a committee headed by PM Modi (as Gujarat chief minister) on tackling inflation, had given 20 broad recommendations to UPA-II along similar lines.