In a surprise move, Reserve Bank of India (RBI) Governor Raghuram Rajan cut down the key interest rate by 0.5% on Tuesday, passing the buck to the Finance Minister Arun Jaitley to take necessary fiscal measures for revival of the economy.
This was the biggest rate cut in three years. The fourth policy rate cut by Rajan since January takes up the total rate cuts to 1.25% in ten months. The banks have passed only an average of 0.3% to the borrowers against the RBI’s 0.75% cut in the last three installments of 0.25% each.
As the RBI also lowered its economic growth forecast for the current fiscal to 7.4% from its previous projection of 7.6%, the foremost task facing the Finance minister will be to impress on the banks—at least government-controlled ones—to pass the benefit of the rate cut to customers to stimulate growth.
“While the Reserve Bank’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed…”
– Raghuram Rajan, RBI Governor
Now that the Government cannot put the blame on the RBI for not aiding in revival of the economy through monetary intervention, Jailed will have to supplement Rajan’s effort by accelerating the pace of reforms that have kept the foreign investors on tenterhooks and prompted international rating agency like the Moody’s to downgrade India’s growth target.
Rajan’s move caught the street by surprise as most polls had predicted a .25% reduction in interest rate. In fact, the Sensex trailed all along in red, one time dipping by almost 400 points, before it staged a smart recovery and shot up nearly 350 points after the RBI’s cut benchmark repurchase (repo) rate from 7.25% to 6.75%. This is the lowest repo rate in four-and-half-years.
Rajan justified the reduction saying consumer inflation was likely to be at 5.8%, below the 6% target for January.
“Our task should now shift to lowering inflation to around 5% by March 2017″, Rajan said, adding that RBI will be vigilant for signs of monetary policy adjustments that are needed to stick to the `deflationary path’.
Not ruling out further interest rate cuts, Rajan said that “continuing policy implementation, structural reforms and corporate actions leading to higher productivity will be the primary impetus for sustainable growth”.
Under pressure to pass the benefit of RBI rate cut to customers, several banks came forward to lower the rates, though only partially. The country’s largest lender SBI lowered its lending rate by 0.4% and the largest private sector lender ICICI Bank hinted at cutting its base rate by at least 0.25%.
“Clearly, interest rates will come down, base rates will come down. A large part of the cut will get transmitted. When I say a large part of the thing (repo rate) will get transmitted, it should mean more than half,” ICICI Bank’s managing director and chief executive Chanda Kochhar told reporters at the RBI headquarters.
Uday Kotak of Kotak Mahindra Bank advocated the need to cut small savings rates by a similar measure of 0.50% to around 8.25% level.
“Saver has a psychological issue if it goes below 8%. It starts getting tougher to get money unless he is made to understand that inflation rates are dropping significantly,” he said, adding his banks will take follow-up measures to reduce the ending rate soon.
“Of the 0.75% cut that has happened (before today’s cut), about half has been transmitted, this half will get transmitted soon,” private sector lender Axis Bank’s head Shikha Sharma said.
Welcoming RBI’s decision, Jaitley said, “This decision of the RBI will significantly provide policy support to the real economy and help in the recovery process. We are looking forward now to the transmission of these cuts which will effectively help to boost confidence and investment. They will also help to realize the economy’s medium term potential growth rate.”
Jaitley will now have to ensure that urgent measures are taken to boost India’s exports that have seen negative growth in the last nine quarters. The Government will also have to take Opposition parties together for passage of the Goods and Services Tax (GST) Bill. That is where the result of the Bihar assembly polls could be crucial. A victory for the NDA will expedite the process of reforms. Conversely, if the NDA loses, the Government will struggle in parliament to take legislative measure needed for revival of the economy.
RBI policy review Highlights
Following are the highlights of the Reserve Bank’s Fourth Bi-monthly Monetary Policy statement for 2015-16:
- Cuts interest rate by 0.5% to boost economy
- Repo rate adjusted to 6.75%, lowest in 4-years
- Expects banks to pass on entire benefit to borrowers
- Cash Reserve Ratio (CRR) remains unchanged at 4%
- GDP forecast for 2015-16 lowered to 7.4%
- Tentative economic recovery underway, far from robust
- Global environment looking weak; not good for India
- Growth likely to pick up in later part of this fiscal
- Consumer Price Index (CPI) inflation expected to reach 5.8% in January 2016
- Inflation is likely to go up from Sept
- Foreign Portfolio Investment (FPI) limit in debt securities to be fixed in Rupee terms
- FPI investment limit in govt bonds to be hiked to 5% by 2018
- RBI to issue final guidelines on base rate computation by November-end.
- Fifth Bi-monthly Monetary Policy on December 1
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