Opinion: Raghuram Rajan Should Surprise with a 50-Basis Point Repo Cut

The Nifty has corrected almost 12 per cent from the early March top of 9,119. The market correction was always on the cards as the rally was driven by foreign flows, particularly exchange traded funds. The froth in the markets was on the back of these three reasons:

1) Global investors were "overweight" India.

2) Markets ignored weaker-than-expected corporate earnings.

3) The unexpected outperformance of China.

Foreign investors booked profit aggressively in April-May, with money seeing rotation into other markets like China, and also some money finding its way back into the US, where bond yields have started to rise in anticipation of Federal Reserve raising rates later this year.

The recent underperformance of equity indices has taken some sheen of the Modi government. Most investors are now complaining about the lack of speedy reforms. Slower-than-expected disinvestment strategy has put pressure on government borrowing, while lack of passage of important bills like the land acquisition bill have dampened sentiments.

The next cut for domestic stock markets is Reserve Bank's monetary policy announcement on June 2. There's expectation that the RBI will cut repo rate by 25 basis points, and this seems to be factored in by markets, evident by the way public sector banks have gained despite weak Q4 results. Bond yields on the 10-year government paper is trading at near 4-year lows.

Pull back in global oil prices, weaker-than-expected monsoon rains and the strength in the US dollar amid speculation that the Federal Reserve will start raising interest rates in the US are likely to weigh on the RBI's decision.

However, with the economy just not growing fast enough and domestic demand not seeing a pick-up, a surprise 50-basis point cut could come on Tuesday, according to some sections in the markets. The same could be the right antidote to revive a lacklustre economy.

The main contributor to the slow improvement in the economy is the high cost of money. The tight monetary policy unleashed by the previous RBI governor managed to kill growth from near 10 per cent in 2009 to below 5 per cent in late 2014.

The present governor has done a commendable job since September 2014 but unfortunately he has also been very tight-fisted at a time when the economy needs the 'elexir' of low rates desperately. The governor has been behind the curve and has kept the repo rate at 7.5 per cent when the need of the hour was at least 100 basis points lower over the year.

With Finance Minister Arun Jaitly and Chief Economic Adviser Arvind Subramaniam both voicing for an aggressive reduction in interest rates, all eyes will be on Governor Raguram Rajan.

Can he do the unexpected & cut rates by 50 points?

(Sanjiv Bhasin is consultant (corporate affairs) and member (core strategy group) at Indiainfoline Ltd.

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