The Reserve Bank of India (RBI) Governor Urjit Patel speaks during a news conference after the bi-monthly monetary policy review in Mumbai, India, October 4, 2016. Photograph: (Reuters)
This could mean banks lending at lower interest rates, transferring the benefits to the end consumer
India's important monitory policy decision over rate cut will be made on Wednesday by the Reserve Bank of India (RBI).
Today's announcement will be a crucial one, given that demonetisation has wiped out liquidity from the market while infusing additional liquidity in banks.
The six-member monetary policy committee (MPC) will be guiding the RBI on the rate cut. Most experts and analysts predict a 25 basis points rate cut on the back of the slowdown in the economy post the demonetisation move by the government.
RBI governor Urjit Patel who will be addressing the media today, will not only have to deal with questions on the rate cut but also the implementation of the demonetisation move as he will speak to media for the first time since the surgical strike on black money. The key lending rate could be reduced by 25 to 50 basis points.
The current repo rate stands at 6.25 per cent after the RBI governor cut the lending rate by 25 basis points in October.
The decision of the central bank will have multiple effects.
The 25 basis point repo rate cut is likely to be influenced by inflationary pressure on the economy, a possible slowdown, fall in consumer discretionary spending and rupee depreciation to the dollar.
The currency drain out impacts the consumer discretionary spending. Most brokerage reports have given a 1 per cent downgrade on the GDP outlook for India post demonetisation. India has clocked in 7.3 per cent growth in July-September - a number that reflects growth pre-demonetisation.
Whether India can continue the rate of growth remains to be seen. A cut in repo rate will enable banks to borrow at lower interest rates and the banks can transfer the benefits to the end consumer. Even the rising oil prices pose a threat to the economy, impacting the RBI's decision on the repo rate cut.
The central bank will also have to consider the movement in the rupee, as a sharp depreciation of the rupee has ensured withdrawals from the FCNR (Foreign Currency Non-Residential) deposits. A higher demand for dollar depreciates the value of the rupee.
The US Fed rate hike, expected this month at the Federal Open Market Committee (FOMC), will be closely monitored. If the Fed decides to hike rates, it will make the United States a more attractive destination for investors to park their funds compared to the other emerging markets, especially India.
This has a direct impact on the Indian currency and experts feel it could depreciate the rupee further. Amidst these concerns that loom large, the RBI will have to be extremely careful on the extent to which it slashes the repo rate, as inflation and rupee depreciation pose to be major deterrents.