Rate Cut Reprise: Will The Governor Blink?

Over the last couple of months, there have been tailwinds that are pointing towards further monetary easing by the country’s apex bank in its monetary meeting scheduled on May 3, 2013. The most important of all is the surprise fall in commodity prices. Crude oil and gold, which form the lion's share of our import bill, have witnessed a sharp fall in prices in the last one month.

April 15, 2013, was a day that saw the markets truly gobsmacked. That was the day when the prices of gold fell by 9.35%, the worst single day loss (in percentage terms) for the yellow metal since 1983. Although, it has gained a little since then, gold is still down by 10% since the start of April, when it was trading at USD 1600/t.oz.

The other important commodity, crude oil, which forms almost one-third of our entire import bill, fell by 10% in the same period and is currently trading in double digits. The important thing to note here is that this fall in the prices looks to be more sustainable, as gold is fast losing its status as a safe haven asset and higher inventory of crude oil in the US, the world's largest consumer of this commodity, restricts any spurt in its prices.

Beside this, in the month of March 2013, India's trade deficit fell to a two-year low of USD 10.3 billion against an average of more than USD 16 billion during April 2012-February 2013. This was primarily aided by higher export growth of 11% (an 11-month high). Going forward, this is expected to see a further decline as the impact of lower commodity prices seeps in.

According to an estimate, lower prices of gold and crude oil alone have the capability of bringing down the Current Account Deficit (CAD) by 1% in the next one year. As the CAD improves, it will give the RBI much needed elbow room to take assertive action on the rate cut front.

It is not only the falling commodity prices and improving trade balance that will make the RBI Governor's task easier. Moderation in inflation as measured by the Wholesale Price Index (WPI) and Consumer Price Index (CPI) would also help greatly. As compared to February 2013, the WPI and CPI numbers for March both came in lower at 5.96% (6.84%) and 10.39% (10.91%) respectively.

The GDP growth, having fallen below 5% for Q3FY13 (the lowest quarterly growth in a decade), could surely do with a hand at this point. Hence, we would expect the RBI to cut the interest rate by 25 bps in its meeting. Of course, we don't see the regulator stepping too aggressively in what will be his last annual monetary policy statement, as we have seen some false starts earlier, especially in 2012 when he cut the interest rates by 50 bps.

Some prominent economists we spoke to reiterated this view. Shubhada Rao, Chief Economist at YES Bank told DSIJ that she expects a 25 bps rate cut to be effected, but not more. Rao also commented that the GDP growth for FY14 would remain close to 5.9%. Another economist, Achala Jethmalani of Nirmal Bang Securities also expressed hope of a similar repo rate cut but nothing on the CRR front. She said that in FY14, the RBI will slash the rates by a total of 100 bps, including the one on May 3. Jethmalani sees the country’s GDP growth for FY14 at about 6.1%.

In fact, gauging from the movement in bond yield and the price appreciation of interest rate-sensitive stocks, we feel that a 25 bps cut has already been factored in by the market.