Falling WPI inflation rates and slowing growth may leave the RBI with no option, but to cut interest rates. Repo rates are rates at which the RBI lends to banks and a drop in these rates, lowers the cost of funds to banks, which in turn may pass on the lower interest rates to customers thus fuelling credit off take and economic growth.
A 25 basis points cut is almost expected, though, the RBI has surprised in the past and could even cut rates by 50 basis points. However, what maybe a deterrent in cutting rates by 50 basis points would be the CPI inflation which has rallied past the 2 digit mark.
WPI inflation has been dropping and was placed at 7.14 per cent for December 2012, as compared to 7.74 per cent in the corresponding period of last year.
What may also induce the RBI to nudge rates lower is the fact that the government has taken some serious steps in controlling the fiscal deficit. It has already put a cap on LPG cylinders and more recently allowed oil marketing companies to gradually raise the prices of diesel. This may go down well with the RBI along with other reform measures, including FDI in a host of sectors.
The RBI may also lower the cash reserve ratio (CRR) requirement for banks. Cash reserve ratio is a proportion at which banks keep money with the RBI based on their deposits. A cut in the CRR allows banks to keep lesser money with the RBI thus freeing-up more money to lend.
It would be interesting to see what the RBI does on Jan 29, given that in the past it has surprised the markets by either holding rates or cutting rates sharply.
While rate cuts are good to boost growth, the RBI must also consider that dropping interest rates would reduce the income for millions of retired individuals. Also, if real rate of returns turn negative (inflation-interest rates) it would prompt individuals to seek other assets especially gold.