Cut in repo rates depends on sustained lower inflation and slowing economic growth rates. Now inflation has come down gradually over the last few months. Unfortunately, in the last two weeks crude has spiked, which makes a petrol hike imminent and hence the prospect of fuelling inflation once again.
On the other hand, growth has teetered and faltered in the last few quarters, which makes a strong case for rate cuts. In fact, India's GDP is expected to grow by just 6.9% in 2011-2012, as against the 8.1% reported in the corresponding period of last year. However, India's central bank has always indicated in the past that inflation will remain paramount, which means it could easily be at the expense of growth.
Also, the government's fiscal deficit is gone out of control. “Interest rate is going to be determined predominately by what happens to the fiscal deficit. The industry is convinced that no matter what happens to fiscal deficit, the RBI will lower the repo rate,” Montek Singh, Deputy Chairman of the Planning Commission said recently.
His arguments are logical, considering that interest rate cut expectations have gone overboard. To cite an example of how industry has taken rate cuts for granted, one can analyse banking stocks. Some of the public sector bank stocks have almost doubled in the last couple of months on expectations that the RBI would cut repo rates. Reduction in repo rates helps reduce interest rates and enables banks to improve net interest margins and also in reducing non performing assets which have gone up dramatically for banks in the last few quarters.
Clearly, there are huge expectations from the RBI to cut rates. Eventually, rate cuts would happen – but to assume it would happen in March would be a little far-fetched.