Will Dr Rajan Reduce Rates Before He Says Goodbye - Outside View by PersonalFN

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Will Dr Rajan Reduce Rates Before He Says Goodbye
Jul 29, 2016

If you're having a not so good day, all you have to do is read or watch something with an happy ending - Karlene Pitters

Don't we love stories with happy endings? Be it movies, theatre, and in real life. It's human tendency to want good memories.

Similarly, when a key employee resigns, the organisation does not fear a crisis due to the ex-employee's absence in the future, but they thank him/her for their contributions and wish them luck in their endeavours. Interestingly, it won't matter how many times he/she shared differences in opinion with colleagues, and the organisation will seldom badmouth them. Farewell celebrations are an inseparable part of being with any organisation a source of creation for good memories.

Generally, a person leaving the office tries to leave on a good note. Even the strictest person softens a bit when he decides to quit. Can we expect this in the case of Dr Raghuram Rajan, the RBI governor who is due to retire? Will he soften his hawkish stance a bit and lower policy rates before he gives up the chair? We are going to bid adieu to Dr Raghuram Rajan on September 04, 2016.

A steadfast central banker, famous for his emotionless objectivity to monetary management, he is set to announce his last bi-monthly monetary policy statement in this term on August 09, 2016. Like the other RBI Governors, even he has been pressurised not only by the Government, but also by the industry and other forces to lower the interest rates. However, Dr Rajan has remained unmoved even in the trickiest situation. More than anything else, he has followed RBI's pre-set inflation targets while deciding about the policy rates. Whether or not he will loosen up, only time can tell, but the market's anticipation has already started building up.

This view is gaining more acceptance...

A report published by Bank of America Merrill Lynch (BofA-ML) suggested that RBI may cut policy rates by 25 bps at the third bi-monthly monetary policy for the FY 2016-17. The corporate and investing banking firm believes that satisfactory monsoon in most parts of India, softer non-food inflation in June, and weak industrial growth in May might prompt the RBI to cut policy rates. The corporate and investing firm also believes, pulses, one of the primary drivers of the food inflation in India must cool-off before RBI can cut policy rates.

PersonalFN is of the view that, it would be too optimistic to expect Dr Raghuram Rajan to accord a rate cut in the third bi-monthly monetary policy statement for 2016-17 (scheduled on August 09, 2016) policy. Going by his track record, it is unlikely that he would be interested in pleasing the Government, the industry, and other market players who have been lobbying aggressively for him to lower policy rates.

On the contrary, Dr Rajan recently cautioned the Government about the need to protect the independence of the Reserve Bank. He didn't forget to mention that curbing inflation and cleaning up bank balance sheets were the two important initiatives the RBI had focused on in the recent years.

He commented about the all nations including India, "It is important that governments around the world look beyond sometimes uninformed and motivated public criticism and protect the independence of their central bank to act. That is essential for stable, sustainable growth". Countering accusations from a few sections/industry of having plagued economic growth, the RBI Govenor said, "The best way central banks can support growth over the medium term is by keeping inflation low and stable." According to him, the real reason for lower credit growth hasn't been the higher interest rates, it's been the stressed balance sheets of banks. Considering these comments, it looks like he is in no mood to cut policy rates.

Some more factors why RBI may not cut policy rates in August:

  • The RBI has been insisting that banks pass on the benefits of rate cuts to the borrowers. Banks have passed on only about half the benefits of the rate cuts so far. Borrowing rates are high due to this.
  • It looks like the GST Bill will be passed in the ongoing monsoon session of Parliament. It is likely to create inflationary pressure at least in the initiation phases because the services will attract higher tax under GST as compared to the current rate structure.
  • The impact of the roll out of 7th Pay Commission on inflation is still unknown. The RBI is watchful of that.
  • Although the core inflation is still low, food price inflation is still high as far as the household inflation expectations go. Further rate cuts will lead to lower deposit rates-a situation that will worry middle-class savers.

Unlike, the businessmen and ruling parties who will always bat for lower interest rates for their own reasons, middle-class and lower middle-class savers will mainly rely on deposit rates for growing their investments. Unless food inflation comes down, their anxiety won't go away. RBI has set a steep inflation target of 5.0% -- to be achieved by March 2017.

On September 04, 2016, Dr Rajan' farewell could be a happy ending for him and his RBI colleagues, however it's unlikely that he will announce any bonanza in the third bi-monthly monetary policy statement for 2016-17.

Happy endings are best achieved by keeping the right doors locked-- Margaret Atwood

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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