Mumbai: The central bank has paused for breath after three unprecedented months of aggressive reductions in key interest rates and policies to increase liquidity in the domestic financial system. The Reserve Bank of India (RBI) said in its quarterly review of monetary policy on Tuesday that there would be no change in either the key policy rates or the proportion of funds banks have to mandatorily park with it.
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But most economists expect further interest rate reductions in the rest of the year, as the economy slows and inflation drops.
Rajeev Malik, head of India and Asean economies at Macquarie Capital Securities, maintained that “the mother of all monetary easings remains in play, and that the RBI is poised to further cut rates by 100 basis points in the current quarter, and potentially another 100 basis points” in the second quarter of calendar 2009. One basis point is one-hundredth of a percentage point.
RBI also said in an official statement that the estimate of economic growth for fiscal year 2009 was being pared from 7.5-8% to 7% with a “downward bias” and inflation to less than 3% by March.
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The decision to pause surprised most economists and financial sector analysts, but the bond and equity markets took the RBI decision in their stride. The yield on the 10-year benchmark government bond, which traded at 5.85% ahead of the policy, edged up marginally before retracing back to pre-policy levels. The Sensex, India’s most tracked equity index, rose 329.73 points, or 3.8%, to close at 9,004.08 and the Bombay Stock Exchange’s banking index, Bankex, gained 2.91%.
However, RBI governor D. Subbarao, who has aggressively cut the repo rate—the rate at which the central bank injects liquidity into the financial system—by 350 basis points and the reverse repo rate—the rate at which it drains liquidity—by 200 basis points to historic lows in the past three months, kept his options open. He has promised to take “calibrated monetary policy actions as necessary and at the appropriate time”.
But most of the economists do not seem to be convinced that RBI had reason to be tentative at a time when the Indian economy is losing steam. “We think monetary policy needs to be pre-emptive and aggressive. We, therefore, think that RBI erred on the cautious side, and missed an opportunity to get rates down further at the policy meeting,” said Tushar Poddar of the economic research wing of Goldman Sachs.
“Disappointed with the absence of rate cuts” in the policy, Abheek Barua, chief economist of HDFC Bank Ltd, said “more rate action is warranted” and at least 50 basis points cut by March. Citigroup India’s economist Rohini Malkani also expects 100-150 basis points easing of policy rates in 2009.
Options open: RBI’s D. Subbarao. Abhijit Bhatlekar / Mint
Amol Agrawal, an economist with IDBI Gilts Ltd, a firm that buys and sells government securities, also said “this is just a pause” and “we should see some action.”
Indranil Pan, chief economist of Kotak Mahindra Bank Ltd, and Anubhuti Sahay, associate economist at Standard Chartered Bank, said this is not the end of the road for those who have been expecting rate cuts. “We expect more easing in the next few months, possibly a 50-100 basis points cut in policy rates,” said Pan. Sahay expects RBI to bring down the repo rate to 4%, the reverse repo rate to 3% and CRR to 3.5% in 2009.
Subbarao’s priority at this point, however, is convincing commercial banks to cut their lending rates. “In the Reserve Bank’s view, the policy easing done by it in the last few months allows for considerable room for banks to response more actively to the policy cues,” the RBI statement said.
Indeed, public sector banks’ lending rates have come down between 150 and 175 basis points in the past few months and that of major private banks by 50 basis points, but the central bank wants them to cut their lending rates more. This can be done only if they cut their deposit rates and bring down the cost of funds.
Punjab National Bank is likely to cut its prime lending rate, or the rate at which it lends to its best clients, by 50 basis points in the next few days. Union Bank of India chairman and managing director M.V. Nair said he would bring down deposit rates in February.
With equity and debt markets the world over in trouble, companies have been falling back on bank loans to finance their activities—and complain that banks are not adequately eager to lend. The central bank has raised the target of flow of bank credit to the commercial sector to 24% for 2008-09 from 20%, and that of deposits from 17% to 19%.
Robert Prior-Wandesforde, senior Asian economist of The Hongkong and Shanghai Banking Corp. Ltd, said, “The scale of future (rate) reductions will depend on the extent to which the commercial banks play ball by passing on the policy rate reductions and stepping up lending to the private sector.”
Keki Mistry, vice-chairman and managing director of the Housing Development Finance Corp. Ltd, said RBI could have cut the reverse repo rate to disincentivize banks from parking excess funds with the central bank. “What we need to do is to ensure the money passes on to the smaller firms. There is ample liquidity in the system.’’
But every player in the financial system may not have ample liquidity. According to Saugata Bhattacharya, an economist with Axis Bank Ltd, liquidity has been concentrated with a few banks and every bank does not have excess funds. The slowdown in corporate earnings in the October-December quarter will also influence lending decisions as the risks of default may rise, he said.
Rupa Rege Nitsure, chief economist at Bank of Baroda, said there is no demand for credit and RBI has done enough and banks have responded braving the high cost of funds. “Going forward, I think there will be sector-specific fiscal stimulus rather than combined measures or only monetary measures.”
Graphics by Ahmed Raza Khan / Mint
Anup Roy also contributed to this story.