RBI to cut rates by 0.25% in April: Sonal Varma

Despite seeing a rise demand, India’s manufacturing sector slowed to the lowest in March due to raw material issues. The Purchasing Managers' Index (PMI), which measures the health of the manufacturing sector, stood at 54.7 points in March versus 56.6 points in February, due to weakening growth in new orders and production. According to Sonal Varma, India Economist at Nomura India, the number is showing more of a consolidation than a major decline.

Varma told NDTV Profit that there are more issues on the supply side than the demand side and that’s a key takeaway from this data.

As far as the Reserve Bank of India’s upcoming monetary policy is concerned, she said that the central bank will cut key rates by 0.25 per cent (25 basis points) in April as inflation is likely to come down further.

Below is the complete interview. Also watch the accompanying video here.

What's the key takeaway from the March PMI?
 

It looks like it is more of a consolidation but monthly trends can be very volatile. If you look at the numbers, first quarter versus fourth quarter, there is clearly an acceleration in the manufacturing activity. If you look at the details of the breakup, the domestic orders have declined. The firms that were surveyed are saying that there was enough demand but they don’t have enough raw materials to meet that demand. That is one of the reasons why the customers have been slow in giving new orders. So it is very surprising to see that the firms are complaining for the supply side bottlenecks. So the takeaway should be that it is more an issue of the supply than the demand, especially this month.

On one side, the RBI is saying that the demand is not faltering and they can keep rates where they are. But on the other hand, the supply bottlenecks are still impacting growth. 
 

Yes, it is very important. It will have significant implications in the coming years. We have always talked about that there is not enough investment capacity in the economy and typically, investment have a large impact on economic growth. Investments have been very weak in the last couple of years, impacting the potential growth of the economy. The apex bank itself has mentioned previously that non-inflationary rate has come down from 8.5 per cent to 7 per cent now. So we don't have the capacity to grow substantially above 7 per cent because any such growth will only be inflationary and this is not what the reserve bank wants. So, essentially it is pointing to falling potential growth in India.

One positive within these numbers was again the core inflation which will continue to come down, the output price index was suggesting that there is a potential fall in the pipeline as well.
 

That’s right. In fact, it has fallen despite input costs going up. Firms have actually not passed on the high input cost to consumers, which should imply that the demand is not as strong as it should be and we are still growing below trend. The second factor that is already leading to core inflation is that commodity price spiral has not been broad-based. Oil prices are moving up but the non-oil commodity prices have actually low compared a year ago levels.

It is not a broad-based input cost pressure you are seeing, we are picking up but it is still a below trend recovery and probably that is getting reflected in core inflation. There is a disconnect here. The survey data shows that the demand is picking up and there are supply side bottlenecks; it is also showing core inflation as subdued. I would read it more as a forward looking indicator suggesting that you may see some pass through going forward. But as of now, firms are still growing below trend.

Will the RBI cut rates?
 

I think one of the most important windows that the RBI has is to reverse its rate cycle. Secondly, the pre-conditions have been met. The government in the fiscal budget has shown a lower fiscal deficit number and it seems that the RBI takeaway has been positive because of the cap on subsidies and the medium term fiscal rules that the government has talked about. 

Also, core inflation has come down from 8.7 per cent to 5.7 per cent in the February reading and the March reading will be out later next week, where we are expecting core inflation to fall further from 5.7 per cent to closer to 5 per cent. So, we would have seen number of months of lower core inflation reading and those two reasons are why we think the RBI will cut rates by 0.25 per cent (25 basis points) in April.