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Home / Politics / Policy /  RBI signals shift in policy stance with surprise interest rate cut

Mumbai: The Reserve Bank of India (RBI) effected a surprise interest rate cut outside the cycle of monetary-policy decisions early on Thursday and promised that there was more to follow as it signalled a “shift" to an accommodative monetary policy stance citing lower inflation, sending stocks and bond prices higher.

The central bank cut its benchmark repo rate, at which it lends to banks, by 25 basis points (bps) to 7.75% from the current 8%, citing easing pressure on prices, weak demand and lower inflation expectations of households. One basis point is one-hundredth of a percentage point. “These developments have provided headroom for a shift in monetary policy stance," the central bank said, while announcing its first rate cut since 3 May 2013.

RBI’s announcement was welcomed by the markets as stocks and the rupee rose and bond yields dropped on expectations that more rate cuts will ensure economic growth accelerates.

S&P BSE Sensex rose 2.66%, or 728.73 points, to 28,075.55 on Thursday, while the rupee, which at one time strengthened as much as 1% to 62.07 a dollar, gained just 0.2% after the US currency rose globally.

The yield on India’s 10-year benchmark bond closed at 7.69%, compared with its Wednesday’s close of 7.77%. It touched a low of 7.67%—a level last seen on 15 July 2013. Bond yields and prices move in opposite directions.

Bankers and economists are now expecting at least another 25 bps cut in interest rates in 2015, some like Standard Chartered Plc as early as the next monetary policy review on 3 February.

Some others such as Morgan Stanley say that this is the beginning of a big rate cut cycle in which RBI will end up cutting rates by a further 125 bps in the next 12 months.

“Our rate cut forecast is predicated on our view that CPI inflation will stay at closer to 5% in most of the calendar year 2015 as the reduction in fiscal deficit, sustained deceleration in rural wages and lower global commodity prices will mean that inflationary pressures in the economy will be contained," Morgan Stanley economists Chetan Ahya and Upasana Chachra said in a note after the rate cut was announced.

December Consumer Price Index (CPI) data released on Monday showed retail inflation at 5%—below the RBI’s January target of 6%—while the Wholesale Price Index data released on Wednesday showed wholesale inflation inched up to 0.1%.

Ashish Vaidya, executive director and head of trading, India, at DBS Bank Ltd, said the cut was expected as governor Raghuram Rajan had explicitly said rates would be lowered early in the calendar year.

“Now the market will price in more cuts because I believe global growth is likely to undergo a slowdown and economic data will reflect that," said Vaidya. “I expect RBI to cut rates by another 75 bps, which means that 10-year yield could come off to at least 7.55% in the next couple of weeks," he said.

Lower interest rates were reflected by banks almost immediately as Union Bank of India and Kolkata-based United Bank of India both cut their base rate, or the rate below which they cannot lend to borrowers, by 25 bps to 10%.

But more importantly, two of the largest banks in the country, State Bank of India (SBI) and ICICI Bank Ltd, indicated rates are on their way down.

Speaking to reporters in Delhi ICICI Bank managing director and chief executive Chanda Kochhar said she expects RBI to cut rates further and banks will also pass on the rate cuts to consumers gradually.

In a statement, SBI chairman Arundhati Bhattacharya said “the current disinflationary impetus is likely to be firmly entrenched and unwinding".

“We, thus, believe this cut may be just the beginning of a rate easing cycle," Bhattacharya said.

Finance minister Arun Jaitley, who had called for lower interest rates multiple times, called the lower rates a “positive development".

“It will lead to more money in the hands of the consumers and greater spending. It is a positive for the Indian economy. It will certainly help in reviving the investment cycle the government seeks to restore," he said.

However, in its statement accompanying the interest rate cut, RBI said for it to move on lowering rates further, the government will have to move on “sustained high quality fiscal consolidation as well as steps to overcome supply constraints and assure availability of key inputs such as power, land, minerals and infrastructure".

Key inputs will be needed to ensure that potential output rises above the projected pick-up in growth so as to contain inflation, RBI said.

However, industry lobbies demanded more and said the 25 bps cut was too little. In a media statement, Jyotsna Suri, president of the Delhi-based Federation of Indian Chambers of Commerce and Industry (Ficci) said the measure will help improve investor sentiment.

“Ficci hopes this will be the beginning of further cuts in the policy rate, and will enable its transmission into lower lending rates by the banks," Suri said.

The Confederation of Real Estate Developers Associations of India (Credai) chairman Lalit Kumar Jain said the cut “is not enough."

“A reduction of 200 bps (reduction of interest rate by 2%) within short span is needed," a note from the lobby group said.

V.R. Iyer, chairperson and managing director of Bank of India, also expects lending rates to come down. However, she warned banks may not be able to pass on the entire cut in repo rates to borrowers.

“Since pressures due to high slippages exist, credit costs for banks have gone up; and so, they may not be able to pass on the entire repo rate reduction benefit to borrowers. Base rates in some banks may come down by 5-10 bps over the next week or so," Iyer said, adding that subdued corporate demand means the onus is now on the government to ensure new infrastructure projects take off and stalled projects are rekindled.

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