Home / Opinion / Why did Raghuram Rajan cut the policy rate by 50 bps?

The Reserve Bank of India’s (RBI’s) 50 basis points (half a percentage point) cut in repo rate surprised everyone. The expectation had been that the central bank would lower the repo rate by no more than 25 basis points.

While this might seem as a “take that" gesture from governor Raghuram Rajan, who has been under pressure to lower borrowing costs, there are actually sound reasons for the cut. Rajan explained these in his post-policy press briefing.

1. Commodity prices are low, and given low capacity utilization of industry, more domestic demand is needed, especially because global demand is low.

2. The government has reaffirmed its intent to stick to the fiscal straight-and-narrow.

3. Inflation is expected to be 5.8% in January 2016, lower than RBI’s previous estimate of 6%, and 4.8% in January 2017.

To be sure much will depend on commercial banks transmitting the rate cut. The gap between bank rates and the policy rate after this cut is around 3 percentage points.

Rajan said RBI would prevail on the government to help on this front—perhaps a reference to a coming cut in the small savings rate, although it could also be seen as a request to the finance ministry to tell state-owned banks to lower rates.

Tuesday’s rate cut should silence, at least for some time, voices in industry that claimed the governor was the only thing standing between them and a revival in the investment cycle and, consequently, growth. Rajan has done his bit. Now it is up to them.

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