Financial Experts Indicate Possibility of Interest Rate Cut In India

Financial experts believe that a rate cut is imminent in India after indicators suggest that the demonetization exercise has left the economy battered.

The announcement is expected after country’s central bank, the Reserve Bank of India (RBI) holds its bi-monthly monetary policy review this week.

In a crackdown on corruption and black money, the Indian government announced last month that high denomination notes of Rs. 500 and Rs. 1000 were illegal tender. The overnight surprise move resulted in nearly 86 percent of the country’s currency in circulation becoming invalid.

According to some estimates, nearly 70 percent of India’s economy runs on cash and the note ban has affected this segment severely. There are widespread reports that small traders and businesses, various services trades and those involving perishable goods have been majorly impacted due the subsequent cash crunch. Several experts have said that this ongoing cash crunch is likely to have a deep impact on economic growth, including a reduction in Gross Domestic Product (GDP).

The impact on the GDP is estimated to be anywhere between 1 to 2 percent. Former Prime Minister Manmohan Singh has predicted a drop of 2 percent while other experts are expecting the hit would be in the region of 1 to 1.5 percent. Recent economic indicators have hinted at the impact. The latest manufacturing PMI data fell to 52.3 from 54.4 in October while the services PMI dropped to 46.7 in November from 54.5 in October. Any number above 50 is said to indicate growth, but the change clearly indicates a declining trend.

The increasingly possibility of the economy slowing down has thus raised expectations that the RBI would announce a rate cut to boost growth. Economists are predicting that the newly-constituted Monetary Policy Committee (MPC) is likely to vote for a quarter percent point cut soon.

In a statement Radhika Rao, economist at Singapore-based DBS Bank said,

Ahead of the looming US rate hike at the mid of this month and ongoing volatility in domestic financial markets, especially the weak rupee, the MPC would have ideally preferred to wait-and- watch before easing rates. However, the government’s recent banknote ban has raised downside risks to growth for at least two quarters, starting 4Q16

Rao pointed out that the prospect of food inflation bringing down inflation would also support a rate cut. According to her, these factors would result in the MPC considering a 25bp rate cut this weekend another one in the first quarter of 2017. Some analysts are however sceptical of the rate cut having an impact on growth since it doesn’t solve the basic problem of currency shortage.

Chad Simmons

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