BackRBI delivers repo rate cut but hints scope for future reduction limited
The benchmark repo rate now stands reduced to 7.25% from 7.5% earlier; CRR and SLR remain unchanged
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Mumbai: The Reserve Bank of India (RBI) on Tuesday cut interest rates by 25 basis points (bps) for the third time this year, citing weakness in growth, even as it indicated limited room for future rate cuts because of upside risks to inflation. Banks took the cue from the rate and started reducing their base lending rates.
The message, however, sent stock and bond prices tumbling as most analysts and economists predicted a prolonged pause from RBI from here on.
The benchmark BSE Sensex fell 660 points, or 2.37%, to close at 27,188.38 points. Bond prices fell and the yield on the 10-year bond jumped to 7.72%, compared to Monday’s close of 7.64%.
Bond yields and prices have an inverse relationship: as prices rise, yields drop, and vice-versa.
“I would characterize the policy today as neither conservative nor aggressive. It’s in some sense a goldilocks policy. Just right given the current situation," said RBI governor Raghuram Rajan at a press conference after the policy announcement.
“We have used the available room...we have to wait for the data to give us more room," he said, adding that further rate decisions will be contingent on incoming data.
While seeking further cues from data, the central bank also threw the ball in the government’s court. “Strong food policy and management will be important to help keep inflation and inflationary expectations contained over the near term," said the RBI’s policy statement.
The RBI’s benchmark repo (repurchase) rate now stands reduced to 7.25% from 7.5% earlier, a 25 basis point cut that is effective immediately. One basis point is one-hundredth of a percentage point.
The cut in rates came despite an upward revision to the central bank’s projection of inflation, which is now seen at 6% by January 2016, compared to 5.8% earlier. RBI cited a weak monsoon, the rebound in oil prices and global volatility as three possible risks to inflation.
Still, RBI chose to go ahead with a cut in interest rates because of weakness in growth indicators and with a view to encouraging investments which, in the medium term, will help ease supply bottlenecks and keep the economy on a disinflationary path.
“Banks have started passing through some of the past rate cuts in their lending rates, headline inflation has evolved along the projected path, the impact of unseasonal rain has been moderate so far, administered price increases remain muted, and the timing of normalization of US monetary policy seems to have been pushed back. With low domestic capacity utilization, still mixed indicators of recovery, and subdued investment and credit growth, there is a case for a cut in the policy rate today," said RBI in its policy statement, adding that the rate cut had been “front loaded".
At the press conference, Rajan once again nudged banks to reduce their lending rates, pointing out that while deposit rates have come down, lending rates have not.
“If I look at bank fixed deposits, because that is the only thing I can invest in, the rate has come down by one percentage point to 8%. Over time, this has to be passed through to the lending side," Rajan said.
Banks took the message, both from the policy and the governor.
The country’s largest lender State Bank of India (SBI) reduced its minimum lending rate or base rate by 15 bps to 9.70% effective 8 June. This is the second base rate cut by SBI. In April, SBI had reduced its base rate by an identical 15 bps.
Kolkata-based Allahabad Bank and Punjab and Sind Bank, which had not reduced their base rates so far this fiscal year, also announced a 30 bps and 25 bps reduction in base rates, respectively.
“The decision to cut repo rate is welcome and timely. With credit demand expected to perk up, we anticipate such a cut will transmit through the banking system sooner than later," said Arundhati Bhattacharya, chaiperson, SBI, in an emailed statement.
The outlook for the economy remains less than rosy.
As part of its policy, RBI reduced its estimate for growth in the current fiscal year down to 7.6% from 7.8% in its April policy. “Reflecting the balance of risks and the downward revision to GVA (gross value added) estimates for 2014-15, the projection for output growth for 2015-16 has been marked down from 7.8% in April to 7.6% with a downward bias," said RBI in its policy statement.
The bank noted that sustained weakness in consumption spending, especially in rural areas, continues to be a drag on the economy, adding that capacity utilization has also been falling in several industries.
Growth in the economy continues to be below its potential, which is estimated at 8-8.5% under the new GDP data series, said RBI deputy governor Urjit Patel.
Richard Iley, chief Asia economist at French bank BNP Paribas SA said Rajan’s call to front load a rate cut despite risks of a below-normal monsoon and external developments was understandable given the economy’s “flagging animal spirits".
Having made that call, further cuts are unlikely, said Iley.
“Having front-loaded easing, India’s rate-cutting cycle is now most likely over with only a renewed plunge in international oil prices likely to create the space for any further easing from here. With CPI set to push back over 6%, RBI’s monetary policy committee, when it finally convenes, faces a long, hard slog to establish inflation control," Iley said.
Consumer price inflation (CPI) fell to 4.87% in April, the lowest in four months.
RBI has a CPI inflation target of 6% for the current year and aims to bring down inflation to 4% in the medium term. Following a monetary policy agreement signed with the government earlier this year, RBI is now formally an inflation-targeting central bank.
Money market traders reacted with caution to the central bank’s guidance.
“RBI has flagged upside risks to its January inflation target of 6%. From here even if bond yields do not go higher, there is only a limited scope for yields to soften," said Siddharth Rath, head of treasury at Axis Bank Ltd.
Ashish Parthasarthy, head of treasury at HDFC Bank Ltd, agrees that markets will remain range-bound but added that there could be room for one more rate cut if inflation remains in check. “There is more probability of inflation remaining subdued given the slack in the economy. So, I would say that one more rate cut may be possible if data supports it," said Parthasarthy.
While reducing interest rates, RBI kept cash reserve ratio (CRR) steady at 4% and the statutory liquidity ratio (SLR), or the proportion of government bonds that banks need to hold, constant at 21.5%.
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