Room for a shallow rate cut

IT IS LIKELY GROWTH WILL SETTLE AROUND 6.5%, WHICH IS BELOW POTENTIAL & THUS CALLS FOR LOWER RATES

- B PRASANNA SAMEER NARANG

After changing its stance in October from withdrawal of accommodation to neutral, the Reserve Bank of India (RBI) has followed it up with a 50-basis point (bps) reduction in the cash reserve ratio (CRR). This is a positive step given liquidity conditions have seen a substantial change from a large surplus a few months back to a deficit now. The repo rate was unchanged in this policy as expected by most of us in the market, but the governor has attempted to provide as much forward guidance as he could have given the current macro balance. In the October policy, growth and inflation were stated to be "well poised", which has now changed to an emphasis on "restoring balance" between inflation and growth. What does this mean?

The RBI has had to revise its growth projections lower over the course of the last few policies. The trend of downward revision of growth started in August when Q1 growth was revised lower to 7.1% and actual outcome was 6.7%. In October, Q2 growth projection was revised down to 7% as against an actual outcome of only 5.4%. Even in December, Q2 growth has been revised to 6.8% as against 7.4% earlier. While downward revision is much higher now and economic activity is picking up as seen in a number of high-frequency indicators, we expect growth to settle below potential at around 6.5% in H2 as against the RBI's projection of 7%.