OVER TEN days ago, RBI Governor Raghuram Rajan was counselling India’s industry to be patient, saying the country should resist quick fixes. He cited the turmoil witnessed in Brazil, an emerging market peer, after their central bank was pressured to reduce interest rates in a bid to grow fast, leading to a credit spree.
On Tuesday, India’s central bank chief delivered a major surprise — cutting the key policy rate — the repo rate by half a per cent or 50 basis points to 6.75 per cent when the consensus was the cut would be by just 25 basis points as has been the case thrice this year so far.
Despite pressure from many quarters for a deep cut, the RBI had so far preferred a baby-step approach — of lowering rates in small doses. But this time, with prospects looking bleak of global growth rebounding, emerging markets such as Brazil, Russia and South Africa in a spot of bother, and the continuing under-utilisation of domestic capacity, the RBI has provided a monetary stimulus aimed at aiding economic recovery.
With demand conditions still sluggish, as reflected in the slack in factory output with average capacity utilisation of a little over 70 per cent, and with inflation (wholesale and retail) falling faster than the bank’s projection of 6 per cent by early January 2016, the RBI opted to go in for a deeper cut or what it calls “front loading”.
A higher cut may well have been influenced by the RBI’s reading of growth prospects this fiscal compared to the government which is still very positive of a growth rate in the range of 7.5-8 per cent and the fact that global recovery appears far weaker than expected earlier. The RBI reckons that it could be lower, cutting its growth forecast to 7.4 from 7.6 per cent earlier with inflation also expected to slide faster than earlier estimates.
Where the 50 basis points cut today has helped is in forcing banks to react quickly this time unlike the last few rounds where Indian lenders were loath to reduce rates citing technical issues of transmission or difficulties in cutting deposit rates and with a huge pile of bad loans to be taken care of.
India’s largest bank, State Bank of India, was quick off the block lowering rates by 40 basis points, which should see others follow suit soon. Though RBI has cut rates by 75 points so far this year, it has translated into an average lending rate cut by banks of only 30 basis points which has frustrated both the central bank and the government.
Rajan appears to have got the timing right though, coming as it does with the feel-good factor generated by Prime Minister Narendra Modi’s US trip and a few policy pronouncements recently by the government including on tax policies and the US Federal Reserve holding its hand on raising interest rates.
Where Rajan may also have got right is in reversing course unlike his predecessor, D Subbarrao who was criticised for his baby-step approach. In hindsight, many reckon that Subbarao may have erred in not raising interest rates aggressively when inflation was in double digits. It has also helped Rajan that global commodity prices continue to remain low.
The former IMF chief economist and professor at Chicago University said there is always pressure, “threats” and pleadings for rate cuts but what counts for him are policies which are “sustainable and can foster enduring growth”.
“Everybody and his cousin have a theory on how to run the economy,” he said, going on to quickly dismiss suggestions that he is a Santa Claus with the comment that may well be quoted often in the future: “The name is Raghuram Rajan, I do what I do.”
Going ahead, it appears imminent that with today’s rate cut action, interest rates on small savings schemes and the Public Provident Fund and that on provident fund and retirement schemes averaging way above 8 per cent will come down soon. The RBI and the government will discuss this soon.
That may be disappointing to savers but with an effective real interest at above 3 per cent it may be a negative for other segments. Rajan has often said in the past that an effective real rate could be in the band of 1.5-2 per cent to incentivise both savers and borrowers.
The rate cut apart, Rajan did announce a few policy measures which are bound to have a positive impact in the medium term. By allowing foreign investors to buy more Indian government bonds, he would helped create a new set of investors for these securities, besides ensuring that rates remain stable.
It is in keeping with the flavour of this government that new rupee bonds which Indian companies can float overseas have been called as “masala bonds”. These bonds will shift the risk of currency for Indian issuers to foreign investors and in the long run lead to a growing internalisation of the Indian currency.