TO CUT OR NOT TO CUT IS THE QUESTION....

By Ruma Dubey

The market is kind of rallying and rambling, awaiting cues. The March inflation numbers came in at 6.89% v/s 6.95% in Feb. It may seem like a marginal fall but what is worrying is the fact that the fall was not as steep as expected. And this faster-than-expected rise in inflation is what is worrying.  Adding to the stress it the surge in food inflation at 9.84% v/s 6.07% in Feb. Seasonally, the months of summer, dry and arid, usually leads to a spike up in food inflation and thus in the coming months, unless crude cools off, inflation could remain worrying, like always. The expectation is that headline inflation for this fiscal, would more or less be contained around 7% and when the RBI Governor presents the Credit policy tomorrow, he will have to keep this in mind plus the falling industrial growth rate. Well, no one would want to be in his shoes or even anywhere around them for the next few hours!

Like always he has a tight rope to walk on – will it be inflation watch or growth concern? While this time around, he can no longer brush off the falling growth rates, which is very real and the fall is gathering momentum; at the same time he needs to keep his ‘hawkish’ stance on inflation intact, with one eye of food inflation and the other on crude oil. Last time, in March, he pressed the pause button and waited to see what the Govt would do in the Union Budget. But this time around, the pressure is huge on him to cut rates. And pressure is coming even from the Finance Minister Pranab Mukherjee, who after the Feb IIP numbers said, “These figures will have a bearing on the monetary policy announcement. The government, along with the RBI, will take required steps to revive activity in the economy.” Will he play it to the gallery or stay put on his economic compulsions?

There are always two sides to the coin. So on one hand, economists are of the view that a rate cut at this juncture is not justified on economic grounds. And on the other, industrialists give two hoots to inflation and say that it is high time Dr.Rao shifted his focus to growth rates.

A quick look at the two sides of the coin. Those who say that a rate cut at this juncture is not justified, say so on the following facts:

·   Soaring fiscal deficit, which is expected to rise this fiscal too if divestments targets are not met and expenditure not controlled.

·   Soaring cost of crude which comprises of almost 70% of India’s total import basket.

·   Food prices expected to soar in summer months.

·   Falling FII investment in FY12.

·   Falling forex reserve – down by $1.47 billion to $292.92 billion for the week ended April 6, the lowest level in more than two months, largely due to suspected sale of dollars by RBI to arrest rupee fall.

On the other side of the same coin, there are those who have an eye only on growth and they argue:

·      Return of growth will lead to higher revenues and a lower deficit. 

·      Lower rates will cut costs for companies, boost demand and increase output 

·      Lower rates could lead to fresh investment in capacities

·      Rate cut will boost sentiment not just for companies but also markets, which in turn will bring in more FIIs, leading to increase in capital inflows and bring down the current account deficit.

Both arguments hold water and are solid. But Dr.Rao knows all this and more. He should not come under any pressure – neither from the Govt nor the market forces to make an economic decision. He has always done what is good for the economy; infact at this point of time, he seems to be the only Govt agent working towards the good of the people! Thus he should do what is best for the economy and not bow down to the gallery.

For the markets tomorrow, if the rates are cut by 50 bps, the bulls will trample the bears; if the rate cut is 25 bps, it would rally in the green as it would be more or less like a “ho-hum” already discounted kind of rally but if the RBI does not cut rates, it would sulk into the red.