AMID easing food inflation and projections of a global slowdown, the Reserve Bank of India (RBI) cut its key policy rate — the repo rate — by 25 basis points to 6.25 per cent, fuelling hopes of cheaper loans for home buyers and corporates. This takes the rate to its lowest since January 2011.
The unanimous decision to reduce rates was taken by the new six-member Monetary Policy Committee (MPC) under a framework agreement signed with the government, marking a decisive shift in the approach to interest-rate setting in India. Earlier, the RBI governor was technically the sole arbiter of the monetary policy.
It was also the first monetary policy review meeting by new RBI chief Urjit Patel, who succeeded Raghuram Rajan in early September. Since January 2015, the RBI has lowered the repo rate by 150 basis points with its stance being accommodative, with inflation on a downward course and growth yet to rebound.
The markets appear to have factored in a rate cut although economists appeared to have been divided over the policy action in the run-up to Tuesday. The benchmark Sensex index closed at 28334.55, up 0.32 per cent. The ten-year bond yield closed at 6.73, down four basis points, while the rupee closed at 66.46, up 0.18 per cent.
The MPC, chaired by Patel and comprising three external members — all academics — and three RBI representatives met over the last two days before deciding to cut the repo rate and adopted an accommodative stance despite projecting 5.3 percent CPI in retail inflation for March 2017.
The Monetary Policy Report highlighted upside risks to inflation. But Patel said both upside and downside risks are present.
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“After the amendments to the legislation and associated notifications, four plus-or-minus two (CPI inflation range) is what we have to endeavour for. In fact, if you read our March 2015 statement, that makes it very clear,” he said.
“If I look at over the next seven-eight quarters, the government has introduced structural reform policies, which is done to ease supply constraints. There is larger investment in railways and roads, which will improve infrastructure and the ease of doing business,” said Patel.
“Proactive food management has played a crucial role in the past two years and will continue to play a crucial role in times to come. And there has been a sharp improvement in competitiveness ranking. So while there are issues related to upside risks, we always say that the direct impact of house-rent allowances on the CPI will be looked through,” said Patel.
Consumer price inflation had decelerated to 5.05 per cent in August from over six per cent in July as good monsoons and better-than-expected sowing brought down food inflation. The pick-up, however, has been slow with a lower-than-expected first-quarter GDP growth of 7.1 per cent.
The MPC expects strong improvement in sowing, along with supply management levels to improve the food inflation outlook. The committee feels that the momentum of growth will quicken, with a normal monsoon raising agricultural growth and rural demand. It also expects increase in urban consumption-spending following the 7th Pay Commission.
Patel said that the transmission of rate cuts through money markets has been swift and decisive, but less through bank lending and to bank borrowers. “We are hoping that over the next quarter or two, there will be better transmission keeping in mind that the government has also reduced the small savings rates. One thing to distinguish is that with the new lending, the transmission has been much more in terms of the rate coming down,” said Patel.
Former RBI governor C Rangarajan said that the rate action was the right step. “I think that is the right way to go. Inflation targeting is fine, but given all factors, a rate cut was warranted,” he said.
“The committee decision to cut the repo rate was on expected lines. With benign inflation trajectory going forward, the RBI’s policy stance is expected to remain accommodative. Banks will continue to transmit rates based on evolving liquidity scenario,” said Arundhati Bhattacharya, chairman, State Bank of India.
Patel, meanwhile, said that the RBI would deal firmly and pragmatically with stressed assets. The governor said just five sectors — infrastructure, steel, textiles, power and telecom — contribute 61 per cent of the total stressed assets of banks.
While the identification, recording and reporting of bad loans is being done well by banks, the resolution of bad loans remains a concern, he said.
“We will deal with the NPA situation with firmness but also with pragmatism so that the economy does not feel any lack of credit to support the growth in economy. But we must remember that the situation has not occurred overnight and therefore will require skill and thoughtful endeavour to resolve. We are working with banks and the government on the subject,” said Patel.“We have a great MPC. The three external members are of outstanding pedigree, very well known academics. They have been involved in policy making of one sort or another for a long time, and they bring value and dispersion of opinion, which is what the MPC is about. Our discussions were frank, often intense but always friendly. We allowed each other to speak, we ensured that there was no rancour and at the end of the day, we agreed on a resolution that we have placed before the country,” he said.
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