New Delhi: Reserve Bank Governor Raghuram Rajan on Tuesday cut the key interest rate by 0.25 percent, third time this year, meeting market and government expectations of boosting growth by lowering borrowing cost.
Yielding to demands of Finance Minister Arun Jaitley and India Inc, RBI Governor Raghuram Rajan “front loaded” the repo rate cut despite worries of below normal monsoon and its impact on prices.
The Governor asked banks to follow suit and pass on the rate cuts — 0.75 percent since January — to individual and corporate borrowers. Most bankers felt that with Tuesday’s rate cut RBI has provided space for lowering lending and deposit rates. Public sector Allahabad Bank became the first to reduce the lending rate by 0.3 percent.
RBI cut the repo rate (short-term lending rate) from 7.5 percent to 7.25, but left all other policy tools like cash reserve requirement unchanged at 4 percent and Statutory Liquidity Ratio (SLR) at 21.5 percent. Rajan lowered projections of the economic growth as measured by GVA (gross value added) to 7.6 percent from 7.8 percent estimated in April due to global factors and likely impact of below normal monsoon.
At the same time, inflation still remains a worry for the central bank as it expects price rise to remain subdued till August before rising to 6 percent by January 2016. It asked the government to put in place a contingency plan to manage the impact of low food production on inflation, mainly because of expected lower than normal rains.
The other concern for the RBI is rising crude oil prices. Since the last policy in April, the crude oil prices have witnessed an increase of 9 percent. Soon after the policy announcement, the BSE Sensex plunged by over 400 points. The markets, however, later recovered slightly.
Chief Economic Adviser, Arvind Subramanian said: “These cuts are consistent with the trends in the economy including strongly declining inflation, contained current account deficit and ongoing strong fiscal discipline.”
The government and RBI agree that these cuts signify that the economy needs policy support as growth is recovering while the external environment remains weak, he said on Tuesday.
“The government and the RBI will work together to ensure that the macroeconomic (indicators) remain strong while investment and growth are accelerated towards their potential,” Subramanian added.
Announcing the second bi-monthly monetary policy this fiscal, Rajan said that “with low domestic capacity utilisation, still mixed indicators of recovery, and subdued investment and credit growth, there is a case for a cut in the policy rate today”.
Following the downward revision in the repo rate, the reverse repo rate (short-term borrowing rate) has got adjusted to 6.25 percent and Marginal Standing Facility rate as well as Bank rate to 8.25 percent.
Commenting on macroeconomic conditions, RBI said, the domestic economic activity remains moderate with agriculture being the most disappointing following the unseasonal rains and hailstorms in the most part of the country in March.
Rajan said however that the risks to inflation identified in April could cloud the picture with below par monsoons forecast for the second successive year.
He also called for astute food management to mitigate possible inflationary effects in case of failure of monsoon.
Given this background, Rajan said, “A conservative strategy would be to wait, especially for more certainty on both the monsoon out-turn as well as the effects of government responses if it (monsoon) turns out to be weak.
“(But) with still weak investment and the need to reduce supply constraints over the medium-term to stay on the proposed dis-inflationary path (to 4 percent in early 2018), a more appropriate stance is to front-load a rate cut Tuesday and then wait for data that clarify uncertainty,” Rajan said while explaining the rationale behind the rate cut.
Rajan said he expects banks to pass on the policy rate cut to individual and corporate borrowers.
“Banks should pass sequence of lending rate cuts,” he said.
Soon after the policy announcement, SBI chief Arundhati Bhattacharya said there is a downward bias on the interest rate and there would be tendency to pass on the rate cut.
“With inflation coming down and RBI cutting rate by 0.75 percent, banks will look at cutting lending rate,” she said.
Echoing similar views, BoB acting CEO and Managing Director Rajan Dhawan said that “there is rate cut in store for us in the next 2-3 weeks”.
Rajan said strong food policy and management will be important to help keep inflation and inflationary expectations contained over the near term.
Furthermore, he said, monetary easing can only create the enabling conditions for a fuller government policy thrust that hinges around a step up in public investment in several areas that can also crowd in private investment.
This will be important to relieve supply constraints and aid disinflation over the medium term, he added.
“Banks have started passing through some of past rate cuts into their lending rates, headline inflation has evolved along the projected path, the impact of unseasonal rains has been moderate so far, administered price increases remain muted, and the timing of normalisation of US monetary policy seems to have been pushed back,” Rajan said.
The global data however points to not so rosy a picture. The global recovery is still slow and getting increasingly differentiated across regions.
What is more worrisome is the US numbers where the world’s largest economy surprisingly shrank 0.7 percent in the first quarter, even as its currency has been on record high, he said.