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Spike in consumer prices could mean no more cuts this fiscal


Expectations of further interest rate cuts in the current fiscal year are fast fading as consumer price inflation (CPI) has stubbornly remained above 6% for eight of the last nine months.

Economists believe that the monetary policy committee (MPC) of the Reserve Bank of India (RBI) may not be able to do much on rates this year even as the central bank faces a challenging task to ensure government bond yields don’t spike sharply despite record borrowing by the sovereign.

Figures released on Monday showed that consumer prices rose 6.69% in August, little changed from the 6.73% growth in July. More importantly, it was above the upper 6% set before the MPC for the fifth consecutive month and if not for a blip in March when it came a tad below 6%, it would have forced the MPC to write to the government explaining why inflation went beyond the upper band set by law for three consecutive quarters.

Economists expect inflation to come down below the 6% mark by December as supply side issues, especially on food, are resolved and the economic recovery gathers pace in the third quarter. However, chances of a rate cut this fiscal look remote.

“The stubbornly high inflation has limited the scope for additional rate cuts this fiscal. Although we expect CPI to come down below 4% by Dec, cuts thereafter in Q4 might not meaningfully add to the then ongoing demand recovery,” said Saugata Bhattacharya, chief economist at Axis Bank.

Since February 2019, when the current cycle of rate cuts started, RBI has cut its benchmark repo rate by 250 basis points including the 115 basis points since the Covid 19 induced lockdown in March. One basis point is 0.01 percentage point.

Bhattacharya said the central bank has already taken rates to a record low and further cuts may have implications for financial markets as it will dissuade savings and also impact foreign inflows due to lower interest rate differential.

Even as it cannot cut rates further, the central bank has to support higher central and state government borrowings by buying more bonds from the open market and also increasing the borrowing window for state governments.

“The central bank also has to contend with high government borrowing this year and will have to continue to use open market operations to keep yields under check,” said A Prasanna, chief economist at ICICI Securities Primary Dealership.

The central government is likely to cross its Rs 7.1 lakh crore gross borrowing in fiscal 2020 in the first half of the current fiscal year itself. Additionally, about Rs 4 lakh crore is being expected to be borrowed in the latter half of the year. The resultant oversupply of paper is likely to hurt investor appetite and lead to an uptick in yields.

To support the government borrowings, RBI which is also the banker to the government, has bought back about Rs 1.2 lakh crores of government bonds through open market operations to keep investors liquid.

It has also announced a Rs 97,000-crore separate window for state governments to borrow to ensure that demand is taken care off outside the market.

Economists say RBI has its task cut out for the rest of the year as it supports the government efforts to revive growth even as it fights to keep a lid on inflation.

“It is a complicated job of keeping inflation under control and at the same time ensuring that the bond and forex markets are orderly. The central bank will use more tools like open market operations and several rounds of operation twist to keep yields under check,” said Anubhuti Sahay, chief India economist at Standard Chartered. She was referring to the central bank selling short term paper in exchange for long term debt to keep yields from rising.

To be sure, the banking system liquidity currently at Rs 3.70 lakh crore is sufficient. Economists say more liquidity will not help much but the central bank will have to ensure the market appetite for government securities does not decrease. In other words, the RBI will keep its stance accommodative but will not be able to accommodate much.

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