It’s The Best That Governor Rajan Could Have Done
Raghuram Rajan has turned monetary policy into a T20 cricket match with all its glorious uncertainties and stunning surprises. The astonishing part in Tuesday’s policy is not the cut in the benchmark interest rate, which was a foregone conclusion — but the shift in stance by the Reserve Bank of India.
There is absolutely no reason for New Delhi, banks, traders as well as the army of cheerleaders to be put off by just a quarter point rate cut. There’s a far more significant change that the central bank governor has brought in; while he could have done it some months ago, but Rajan, as always, chooses his timing.
His message to banks, his prime constituency, couldn’t have been clearer: lower interest rates, and I will do all that’s possible to create more liquidity in the system and bring down the overall cost of fund. With deposit growth at a 50year low, Rajan softened the penalty on banks for extra borrowing from RBI; it will go down as a hint that banks can overstretch a little (by borrowing short term funds) to step up lending.
For the first time since he took charge in September 2013, the RBI governor has recognised the urgency for easier liquidity — without which any rate reduction by RBI is not transmitted to the end borrower through the banking system. Also, apparent in the policy text is the message that Tuesday’s rate cut will not be the last before his three-year term ends in September.
The moves to create additional liquidity and give some breathing space to banks and bond houses are direct: Repo rate, the rate at which banks borrow short-term money from RBI, has been lowered by 25 basis points to 6.5%; daily balance on Cash Reserve Ratio — the slice of customer deposits that banks have to mandatorily park with RBI — is reduced to 90% from 95%; and the extra interest rate that banks are charged for borrowing over and above their quota under repo is down to 7% from 7.75%. At a time banks are hobbled by sticky assets and low deposit growth, the measures will give lenders the much-needed flexibility.
The assurance that RBI will sustain its pace of open market operations — purchase of securities from the markets to infuse money — will calm the nerves of bank treasurers, bond traders, and badly bruised investors of bank stocks. Active open market operations, which has picked up this year, will support bond prices and cushion battered balancesheets of banks from mark-tomarket losses.
The first bi-monthly policy statement on Tuesday is the best that Rajan could have done. Low inflation, cut in small savings rates, independence in the conducting monetary policy, and New Delhi’s promise to keep fiscal deficit under check — all combined to create the moment for Rajan to deliver.
But, the larger question is, will Rajan shelve the report of his deputy Urjit Patel by slowly bringing in a new monetary policy game towards the close of his (possibly, first) innings? Over the past few years, Mint Street has repeatedly underscored that monetary policy works best when there is liquidity deficit in the system. This has been the premise of RBI’s policy actions so far. Is this about the change? The policy text and Rajan’s conversations with reports lend themselves to interpretation. When a journalist asked him whether RBI would implement the subsequent recommendations of Urjit Patel’s report (as many expected he could), the governor said he “doesn’t remember” the second part.
Analysts and media will continue to interpret such statements as they typically do. But there is no ambiguity in the main takeaway from the policy: amid uncertain growth, global imponderables, and continuous dip in exports, Rajan has acted before it is too late.