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Business News/ Politics / Policy/  Raghuram Rajan went with technical advisory panel’s view on rate cut
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Raghuram Rajan went with technical advisory panel’s view on rate cut

RBI governor Raghuram Rajan also accepted suggestions from committee members to ease liquidity in the system

RBI reduced its repo rate by 25 bps during its monetary policy review meeting on 5 April. Photo: Aniruddha Chowdhury/MintPremium
RBI reduced its repo rate by 25 bps during its monetary policy review meeting on 5 April. Photo: Aniruddha Chowdhury/Mint

Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan accepted recommendations of the technical advisory committee (TAC) to cut the policy rate at its monetary policy review on 5 April, according to minutes of TAC’s pre-policy meeting released on Thursday. Rajan also accepted suggestions from committee members to ease liquidity in the system.

TAC comprises five external members and is chaired by the RBI governor. The deputy governor in charge of the monetary policy is an internal member of TAC, which was formed in July 2005 to strengthen the consultative process on monetary policy.

In the TAC meeting ahead of the April policy, four out of the five external members recommended a reduction in the key policy rate, the central bank said in a statement on Thursday. But there was a divide on the extent of the rate reduction, with two out of the four recommending a deeper 50 basis points (bps) cut in the repo rate, the minutes showed. One bp is one-hundredth of a percentage point.

RBI reduced its repo rate by 25 bps on 5 April and RBI said it would maintain “neutral" liquidity as compared to a deficit of 1% of deposits that it was had been trying to maintain until then.

One external member had noted the divergence between RBI’s stated liquidity framework and the market’s understanding of it. The member questioned whether banks should remain so dependent on RBI for liquidity, according to the minutes.

“Given the centrality of the interest rate under the current framework, the member suggested keeping overall liquidity conditions soft, consistent with the easing stance of monetary policy and suggested that the LAF corridor may be narrowed from (+/-)100 bps to (+/-)50 bps," the minutes detailed.

LAF is short for the liquidity adjustment facility, the primary instrument used by RBI for modulating liquidity and transmitting interest rate signals to the market. It refers to the difference between the two key rates—the repo rate and reverse repo rate.

Another member pointed to the build-up of government cash balances with RBI, which suggested that the centre was holding back spending. Higher currency demand was also impacting liquidity, this person said. The member, however, suggested a cut in the cash reserve ratio (CRR) to avoid the need for frequent bond purchases by the RBI.

The central bank left its CRR unchanged at the policy.

Members who voted for a rate reduction argued that the inflation trajectory had turned favourable, household inflation expectations had moderated and the government’s move to cut the small savings rate made it an opportune time for RBI to push for transmission of rate cuts by opting for another policy rate cut.

“Another factor favouring a cut at the current juncture is the risk of large over-supply of government bonds, which could push bond yields up," according to the minutes.

Some members also felt that there was room for further rate cuts given that India’s natural rate of interest had fallen due to a global demand shock.

Members advocating a 50 bps cut argued that in addition to these factors, the government’s move to stick to its fiscal deficit target of 3.5% of gross domestic product and the ongoing stress on bank balance sheets warranted a deeper rate cut by the central bank.

“One of the two members who recommended a rate reduction by 50 basis points wanted the rate cut to be followed by another rate cut of 25 basis points in the June policy while the other wanted a pause," the minutes said.

Members felt that GDP growth would accelerate gradually and may be more evenly spread across sectors.

Members also felt that although GDP growth was strong, there are several risks to it. Private capital expenditure is getting stymied due to excessive leverage on corporate balance sheets, indicating that fresh spending would be muted in the short-term.

Data from the corporate sector suggested worsening of the situation, the minutes added. The manufacturing sector continues to lag behind with a sharp divergence in the gross value added (GVA) and the industrial output numbers.

However, a normal monsoon, a fall in real interest rates from the peak in fiscal 2016 and seventh pay commission recommendations would give a fillip to consumption.

On inflation, members were cautious and said headline retail inflation would likely be sticky during the course of the year and pointed to several risks. Noting that the recent fall in inflation was mainly driven by a drop in food prices, members argued that elevated levels of services inflation would keep the headline number high.

Other risks include a possible bounce-back in global crude oil prices and the impact of the rupee’s expected depreciation over the course of the year.

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Published: 28 Apr 2016, 06:26 PM IST
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