Interest rates on loans and deposits are set to fall with the Reserve Bank of India (RBI) Wednesday slashing its key lending rate, the repo rate, by 25 basis points to 6 per cent — the lowest level since November 2010 against the backdrop of a steep fall in inflation and weak demand. The decision of the six-member Monetary Policy Committee (MPC) was not unanimous. While members Chetan Ghate, Pami Dua, RBI Deputy Governor Viral V Acharya and Governor Urjit Patel were in favour of a 25 basis points reduction, Ravindra H Dholakia voted for a reduction of 50 basis points while RBI Executive Director Michael Debabrata Patra argued for status quo.
The RBI cut is likely to put pressure on banks to lower interest rates on home, auto and personal loans further. Bankers and analysts said the cut in the policy rate was largely anticipated and the timing opportune as both the US Federal Reserve and the European Central Bank would begin their unwinding measures in the near term, making it difficult for any policy cut decisions by the RBI thereafter. On the other hand, the steep fall in inflation and the weak industrial and investment scenario put pressure for a rate cut sooner than later.
Unveiling the bi-monthly monetary policy, the MPC observed that some of the upside risks to inflation have either reduced or not materialised. “The baseline path of headline inflation excluding the HRA impact has fallen below the projection made in June to a little above 4 per cent by the fourth quarter. Inflation excluding food and fuel has fallen significantly over the past three months and the roll-out of the GST has been smooth and the monsoon normal,” MPC said in its resolution after a two-day meeting.
“Consequently, some space has opened up for monetary policy accommodation, given the dynamics of the output gap. Accordingly, the MPC decided to reduce the policy repo rate by 25 basis points. Noting that the trajectory of inflation in the baseline projection is expected to rise from current lows, the MPC decided to keep the policy stance neutral and to watch incoming data,” Governor Patel said. The RBI also readjusted the reverse repo rate — the rate at which the RBI borrows from banks — to 5.75 per cent.
Patel said banks have been selective in their rate cuts in aggressive segments like home and auto loans, but there are many other segments, especially those, where borrowers are still tied to the base rate, where they can do more. “Given the liquidity conditions prevailing and that we have reduced policy rates by substantial amount since start of easing cycle, I think there is scope for banks to reduce lending rate for those segments. So far, they have not benefited to the full extent of our policy rate cuts.”
The MPC remains focused on its commitment to keep headline inflation close to 4 per cent on a durable basis, the RBI said. For the first quarter of fiscal 2018, retail inflation averaged 2.2 per cent, which is closer to the lower bound of the MPC’s forecast (2-3.5 per cent) for the first half of the year. For the second half, the MPC forecasts inflation around 3.5-4.5 per cent.
“The recent dip in inflation was accentuated by demonetisation-led crimp in demand and seasonal downside pressures on food, most of which are temporary and will soon fade. What is comforting is that beyond this noise, there are other factors that will act as bigger curbs,” rating agency Crisil said. The industry, however, said the RBI should have gone for a deeper cut of 50 bps. “The current situation warranted a steeper cut of 50 bps in the repo rate. The private investment cycle remains weak and the reduction in the rate will be an investment sentiment booster. According to FICCI’s latest Business Confidence Survey findings, companies are still operating at sub-optimal capacities and the demand conditions also remain a concern for businesses,” FICCI president Pankaj Patel said.
On the state of the economy, the MPC said there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all, the RBI said. “This hinges on speedier clearance of projects by the states. On their part, the government and the Reserve Bank are working in close coordination to resolve large stressed corporate borrowers and recapitalise public sector banks within the fiscal deficit target,” it said.