Retail inflation eased to a five-year low of 3.65% in August, but numbers can tell a different kind of truth. Even though headline inflation indicates that the worst was over, households are yet to feel it, as budgets continues to rise. Worryingly, analysts have also warned us to brace up for a bad number in both September and October months, when inflation will likely stay below or close to 5%, or above RBI’s target.
In other words, these numbers are a mathematical confirmation of our suspicions that a rate cut is unlikely this year. In fact, SBI Research believes the first interest rate reduction may come in as late as February, 2025.
“As such, we don’t anticipate any rate action by RBI in calendar 2024. An early 2025 rate cut (February) looks the best bet as of now. We still believe that liquidity challenges will remain for the banking sector with government cash balances progressively moving out of the banking system” it noted.
The rule of the thumb is that it takes about 12-18 months for an interest rate action to fully filter through the economy. It’s been over 28 months since the first hike in this tightening cycle, which begs the question if RBI is waiting too long to cut? Is it behind the curve and must jump-start the process with a larger, half-point cut?
As Investopedia notes, a central bank gets behind the curve when it’s not raising rates at a pace fast enough to keep up with inflation. Conversely, it can get ahead of the curve by increasing rates at a pace faster than inflation suggests it should be.
Between May 2022, and February 2023, RBI raised rates by 250 bps, but the transmission itself isn’t even and complete. According to its September monthly bulletin, the 1-year median marginal cost of funds-based rate (MCLR) of banks increased by 170 bps during May, 2022-August, 2024. The weighted average lending rates on fresh and outstanding rupee loans increased by 189 bps and 119 bps, respectively during May,2022-July, 2024. As for deposits, the weighted average domestic term deposit rates on fresh and outstanding rupee term deposits increased by 245 bps and 189 bps respectively, during the same period.
Now at this juncture, a potential global rate-cutting cycle may work in astonishingly intricate ways. For starters, India could see increased dollar inflows, which is good for equities and debt markets, but it can also affect our currency management and jolt inflation back into a beast mode should domestic money supply expand. So the MPC’s task is cut-out, to ensure that its pivot won’t force us out of the frying pan into fire. Besides timing, questions also persist about the quantum of rate cuts, whenever they arrive.
During his initial years, Das bucked convention announcing 40 bps rate cuts as against the traditional quarter-point cuts. Will he take a bigger swing at rates in December, if not October, when his tenure comes to a close? Or not?
Theoretically, rate cuts have a positive vibe as they reduce the cost of capital, but there’s an unglamorous part to it. Central banks often cut rates when they expect economic conditions to worsen drastically, and hope that their rate actions will likely soften the blow, or sometimes even prevent a recession. Unsurprisingly, recessions begin after rate cuts.
And should they pass on a jumbo rate cut of 50 bps, a hundred questions will rise like flies disturbed at a feast, even as markets turn into a mass of nerves. Strangely though, Fed’s unexpected half-point rate cut last week didn’t spook markets. On the contrary, stocks surged a day after the Fed’s rate move with the Dow Jones Industrial Average closing above the 42,000 level for the first time, while the S&P 500 scaled up 1.7%, also touching a record high.
In the past, super-sized cuts have come before a recession. Both in 2001 and 2007, when the Fed raised rates by 50 bps, the sharp cuts weren’t enough to stave off a recession. However, there’s growing optimism that the Fed’s rate cuts will lead to a soft landing, where the economy slows enough to tame inflation but not so much that it tips into a recession.