March 5, 2015 12:47:10 am
Just days after the Union budget, the RBI has reduced its policy rate by 25 basis points, taking many by surprise, including the markets. Even though it is in line with monetary policy easing by several central banks globally, including China’s, this is an unscheduled move. Governor Raghuram Rajan has laid out the reasons why the central bank acted outside of the next policy review scheduled for early April. The still weak state of certain sectors of the economy as well as the global trend towards easing would suggest that any policy action should be anticipatory once sufficient data supports the policy stance. Besides, with a new monetary policy framework in place, marked by a mandated inflation target, it was only appropriate for the RBI to offer guidance on how it will implement this mandate. What has also weighed on the RBI is the expected further easing of inflationary pressures in the first half of 2015-16, hopes of better quality fiscal consolidation this time around, low capacity utilisation and industrial output as well as weak loan growth.
There are three distinct features in the latest rate cut. One, this is the second “out of policy” cut, after the surprise cut in January. Two, this is the first after the monetary policy agreement between the RBI and government. Three, this is a baby step just like the earlier one and not a steep (50 basis points or more) cut that the Centre and India Inc may have wanted. The picture will become clearer when the RBI unveils its monetary policy for 2015-16, but it is possible that the central bank is not fully satisfied with the fiscal consolidation undertaken in the budget. There is no significant increase in capital expenditure in this year’s budget to justify a deviation from the original deficit reduction roadmap. And nothing has been done with respect to subsidy rationalisation. Yet, the RBI has still gone ahead with a 25 basis point cut mainly because the underlying inflationary momentum in the economy has receded. Also, growth needs a strong push at this moment.
For the latest policy action to transmit downwards, banks will have to act in terms of passing on the reduced repo borrowings costs. Strangely, most of them have not reduced lending or deposit rates, even after the last round of cuts in January. The rate cut is positive for banks, especially those whose earnings are under pressure and who now stand to book treasury income gains. Hopefully, both industry and government will now take the cue and get going, especially on infrastructure, with expectations of further rate cuts down the line.
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