Four reasons why RBI may not cut rates on Tuesday

The debt-ridden Greece crisis  has receded for the time being.  The geopolitical risks from Russia  and Ukraine are also not dictating the financial markets  any longer.  Crude prices are on the downswing to $55 a barrel and inflation (CPI) is under 6 per cent as targeted by the Reserve Bank of  India (RBI) by January next year. The drought-like situation portrayed one and a half months ago has also receded to a great extent.

This happy situation brightens the chances of another 25 basis points cut in the repo rate , which sets banks' lending rate as the banks borrow from the RBI at this short term rate.  The repo rate is currently at 7.25 per cent. Since January this year, RBI has reduced the repo rate by 75 basis points.

But there are new threats emerging in the economy, which put greater risks on inflation going forward. Take a look:

i) Rupee depreciation and the threat of imported inflation

The rupee has been weakening against the US dollar of late after stabilising at Rs 60 levels after a low of 68-69 in  the first half of 2013. In fact, RBI Governor Raghuram Rajan initiated a series of measures like permitting banks to borrow dollar deposits, which  stabilised the rupee to 60 levels. Now, the rupee has started weakening to 64 levels, which gives rise to the threat of imported inflation as one of the biggest import items is crude oil.

ii) US Federal Reserve to kick-start interest rate hikes

After keeping interest rates at near zero for close to seven years, the US Federal Reserve will soon be taking a call to start raising short-term Fed rates. This could become reality in September. In fact, one of the reasons for the rupee's depreciation is in anticipation of rising rates in the US and the consequent outflow and reduced dollar flow into India. Clearly, the turn of interest rates cycle will be gradual and it will only move up.

iii) Widening fiscal deficit

At the start of the full-fledged Budget 2015/16 of the new BJP-led NDA government , all eyes were on the fiscal deficit numbers. While the government has pegged the fiscal deficit target of 3.9 per cent in the current year , the latest numbers for the first three months (April-June) are not very encouraging. In the first three months, the fiscal deficit has already crossed 51.6 per cent of the budgeted figures.  Last Friday, Finance Minister Arun Jaitley surprised all with an additional Rs 25,500 crore  allocation in the current budget. A major part of this money would go to recapitalisation of  PSU banks.    
 
iv) Finally, the CPI numbers

There is still volatility in the CPI numbers . The latest figures of June  reflect a rise to 5.4 per cent as compared to 5.01 per cent in June this year.  While the CPI numbers are below the RBI targeted number of 6 per cent, the sudden uptrend could be cause for alarm. Onion prices, for example, are already soaring. There could be other food items springing a surprise  because of the impact of unseasonal rains and also inadequate monsoon.