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Rajan prunes repo by 25 bps, seeks transmission by banks

The Reserve Bank of India on Tueday cut its policy interest rate by a quarter percentage point, lowering it to a more than five-year low while dangling the prospect of another cut later this year if inflation trends stay benign.

Written by George Mathew | Mumbai | Updated: April 6, 2016 1:33:37 am
rbi, rbi rate cut, repo rate cut, rbi repo rate cut, rbi governor raghuram rajan, rbi basis point cut, rbi loan rate cut, rbi news, reserve bank of india, business news, economy news, indian economy, indian express news RBI Governor Raghuram Rajan during a press conference announcing the RBI monetary policy at RBI Headquarters in Mumbai. (Source: File/PTI Photo)

The Reserve Bank of India (RBI) on Tuesday cut its key policy rate, the repo rate — the rate at which it lends to banks — by 25 basis points to a five-year low of 6.50 per cent while indicating a further cut in the offing.

But Tuesday’s move fell short of market expectations as many had hoped for a 50 bps cut. Such hopes were fuelled with the government sticking to the fiscal consolidation path in the Budget and later reducing the rates on small savings schemes.

RBI Governor Raghuram Rajan said that ensuring that current and past policy rate cuts transmit to lower lending rates was more important. What he implied was that despite the central bank lowering rates by 125 basis points since 2015, banks have reduced rates only by close to 60 basis points. The RBI appears keen to ensure that the benefits of a rate cut translates into lower borrowing costs for firms and individuals and also assess the prospects of the monsoon before committing to an aggressive cut in rates.

The reduction in small savings rates announced in March, the substantial refinements in the liquidity management framework announced in this policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission and magnify the effects of the current policy rate cut, Rajan said.

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Rajan promised that the stance of monetary policy will remain accommodative and the “RBI will continue to watch macroeconomic and financial developments in the months ahead with a view to responding with further policy action as space opens up”.

In order to ensure better transmission of rates, the RBI Governor also announced structural changes in the central bank’s liquidity management policy with banks complaining of liquidity problems. To address that the RBI has reduced the Marginal Standing Facility or MSF by 75 basis points while also easing the requirement of maintaining a minimum daily cash reserve ratio — from 95 to 90 per cent.

The RBI has also raised the reverse repo rate by 25 bps and narrowed the interest rate corridor — the gap between the repo rate and the reverse repo rate — to 50 bps. Besides, it has lowered the limit of banks’ daily cash balance with the RBI from 95 per cent to 90 per cent and raised the rate on marginal standing facility to 7 per cent. All these will ease the pressure on liquidity and lead to faster transmission of the policy rate.

These steps are expected to bring down the cost of borrowing and help fuel economic growth. Against this background, the RBI has kept the growth projection for FY17 unchanged at 7.6 per cent even as inflation projection remains at 5 per cent by March 2017.

According to the RBI, the changes to the RBI Act to create a monetary policy committee will further strengthen monetary policy credibility. In the FY17 Budget, the government has adhered to the path of fiscal consolidation and this will support the disinflation process going forward. “Given weak private investment in the face of low capacity utilisation, a reduction in the policy rate by 25 bps will help strengthen activity and aid the government’s initiatives,” Rajan said.

On the price front, Rajan said there are uncertainties surrounding this inflation path emanating from recent unseasonal rains, the likely spatial and temporal distribution of monsoon, the low reservoir levels, and the strength of the recent upturn in commodity prices, especially oil.

“The persistence of inflation in certain services warrants watching, while the implementation of the 7th Pay Commission awards will impart an upside to the baseline through direct and indirect effects. There will be some offsetting downside pressures stemming from tepid demand in the global economy, government’s effective supply side measures keeping a check on food prices, and the Government’s commendable commitment to fiscal consolidation,” he said.

The Confederation of Indian Industry (CII) said that the rate cut from the RBI could have been higher in the current economic conditions which would have had a stronger impact on sentiment and spurred investment. “Factors such as soft commodity prices, expectations of a normal monsoon, cut in small savings rate and the government delivering on fiscal prudence in the Budget have made it the right time for the RBI to lean more towards growth,” CII said.

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