Thursday, 22 January 2015

Rate cut in the near future

The time for a rate cut may be coming up fast even earlier than expected. The macro and micro-economic factors have been favorable and are pointing in the right direction. The favorable factors should make it easier for the Reserve Bank of India (RBI) to commence the long-awaited descent journey of interest rates.

The latest economic data has been a pointer to this effect. The industrial growth rebounded to a five-month high in November. At the same time, the consumer inflation didn't accelerate to the extent anticipated in December despite an adverse base effect. The economic indicators point towards the fact that the economy has now started looking up and inflation is under control. These will support the demand for a rate reduction.

According to the latest data released, the industrial growth rose by 3.80 percent in November, reversing the sharp 4.20 percent contraction in the previous month. Further, the consumer inflation rate moved to five percent in December from 4.38 percent in the previous month. This is in line with the consensus expectations of a 5.20 percent rise in the inflation rate. The Consumer Price Index (CPI) based inflation rate for December appears to be within the RBI's target range. As such, there is now an expectation that the RBI may lower the policy interest rates in the coming weeks.

The manufacturing sector, with a 75 percent weight in the Index of Industrial Production (IIP), rose by three percent in November against a 7.40 percent contraction in the previous month, adding to signs of strength. Electricity generation rose 10 percent while mining output was up 3.40 percent in November. Capital goods, an indicator of investments, posted growth for the fifth time this fiscal in November, up by 6.50 percent.

The CPI declined month-onmonth, showing that the softening bias in prices has continued. The core CPI for December fell further to 5.23 percent from 5.51 percent in the previous month. The core CPI has been consistently declining since January 2014, when it stood at 8.10 percent. The consumer food price index sped up sharply to 4.78 percent in December from 3.14 percent in the previous month. The marginal rise in retail inflation should not prevent the RBI from cutting the benchmark interest rates. The food inflation rate surged as prices of some food items, including fruits and vegetables, increased. Food inflation rose to 4.78 percent in December, from 3.14 percent in the previous month.

Acceleration in the CPI based inflation rate and improved factory output performance could put pressure on the RBI to cut the policy interest rates before the upcoming Union Budget in February .

All this should spell good times for home loan borrowers. They can expect a reduction in the interest rates in the near future and consequently their EMIs. For prospective borrowers, who are planning to purchase property, opting for a floating rate loan as against a fixed rate loan will make sense. As the interest rate on a home loan offered by a bank is linked to the base rate of the bank, a reduction in the policy rates by the RBI will lead to a lowering in the base rate of the bank. This in turn will lead to a reduction in the interest rate on the home loan for a borrower of a floating rate loan.

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