Why the RBI may still cut rates despite a falling rupee

Headline inflation in June snapped a four-month easing trend, but at 4.86 per cent it is still within the comfort zone of the Reserve Bank of India (RBI), raising hopes of a rate cut on July 30.

Chairman of the Prime Minister's Economic Advisory Council Chairman C Rangarajan told NDTV that the central bank may have room to cut rates because food prices are expected to ease following a good monsoon.

"Two factors, the depreciation of the rupee, the good monsoon and therefore inflationary expectation from the food front may come down, therefore one may offset the other," Dr Rangarajan said.

RBI Governor Duvvuri Subbarao on Monday after meeting Finance Minister P Chidambaram said, "Of course we will take into account inflation numbers. Beyond that I have no comment."

Global investment bank Barclays said while RBI's current focus is containing the rupee weakness, on a more medium-term perspective, reviving growth in a non-inflationary manner will remain a major concern.

"We think monetary policy calibration will be biased towards further easing, rather than tightening," Barclays said in its report.

However, most analysts have discounted the possibility of monetary easing on account of the unexpected collapse in the Indian rupee.

"As long as CPI inflation remains close to double-digits and the balance of payment at risk, we expect the RBI to remain on hold," Sonal Varma of Nomura said.

The government has been arguing that a rate cut is needed to kick start the economy, which last fiscal grew at the slowest pace in a decade at 5 per cent.

The central bank also seems to have trained its sight on the external situation after the sharp fall in the rupee. The RBI in its last monetary policy meet kept interest rates unchanged after cutting them in each of its previous three policy reviews, warning of upward risks to inflation posed by a falling rupee and increases in food prices.

The rupee has been the worst performing Asian currency, falling nearly 10 per cent in the last three months. Last week the rupee fell to an all-time low of 61.21 against the US dollar.

On Monday the rupee once again breached the psychological 60-mark.

(With imputs from Reuters)