RBI Cuts Rate 25 Bps, But Doesn’t Ease Its Stance
Mumbai: The Reserve Bank of India (RBI) cut the key interest rate by a quarter point to 6% as expected without changing its stance, saying that it would remain on guard as price pressures may return in the wake of a house rent allowance payout and the July 1 rollout of the goods and services tax (GST). The Monetary Policy Committee (MPC) admitted that its inflation expectations have not materialised, but said it was difficult to conclude whether the easing of price pressures was temporary or permanent in nature. It therefore kept its stance at “neutral” instead of shifting to “accommodative”, which would have indi- cated more scope for the lowering of rates in the months ahead. Four MPC members voted in favour of the 25 basis point (bps) cut while one was in favour of a 50 bps reduction and the sixth wanted no change. A basis point is 0.01 percentage point. In an ET poll of 20 market participants on the weekend, 17 had expected a 25 bps reduction. The economic growth forecast was retained at 7.3% amid prospects of a better harvest even though the industrial sector continues to struggle, which is partly due to a debt overhang. Inflation projections have been lowered marginally to just above 4%, from the top end of the band of 4.5% forecast earlier.
Since “inflation is expected to rise from the current lows over the rest of the year, the committee persevered with the neutral stance,” RBI governor Urjit Patel told reporters. “With several factors contributing to uncertainty around the baseline inflation path, implementation of farm loan waivers, the after-effects of GST, the timing of implementation of salary and allowance revisions by state governments, the MPC emphasised its commitment to keeping headline inflation close to 4% on a durable basis.”
This is the first cut in the repo rate — at which the central bank lends to banks — since October 4 last year, which also happened to be the inaugural meeting of MPC. The cash reserve ratio (CRR), the proportion of cash that banks have to keep with RBI, was kept unchanged. The benchmark Sensex declined 0.3% to 32,476.74 points while the rupee rose to its highest level in two years to 63.70 against the dollar. Ten-year government bond yields rose two basis points to 6.46%. “Given our expectation of both growth and inflation rising over the next six to 12 months, we expect a prolonged pause from RBI,” said Sonal Varma, economist at Nomura Securities. The government, which has been arguing for lower interest rates, was guarded in its response while acknowledging the cut. “We welcome the 25 bps cut in the repo rate as an important step necessary to converge toward the appropriate real monetary conditions for sustained growth consistent with India’s potential and for stable, moderate inflation,” said economic affairs secretary Subhash Chandra Garg.
Inflation as measured by the consumer price index (CPI) fell to a record 1.54% in June, prompting calls from the government to lower interest rates. Chief economic adviser Arvind Subramanian had even questioned the credibility of RBI’s inflation forecast.
Furthermore, the argument has been made by some critics that India’s real interest rate is the highest in the region and coupled with rupee appreciation this year makes the monetary policy a tight one.
“There are several factors contributing to uncertainty around this baseline inflation trajectory,” the policy said. “Implementation of farm loan waivers by states may result in possible fiscal slippages and undermine the quality of public spending, entailing inflationary spillovers.”
The policy statement is carefully worded and doesn’t necessarily point toward which way rates could go.
“Accompanying rhetoric is largely neutral, without giving away particular bias for the rate trajectory,” said Radhika Rao, India economist at DBS Bank. “The latter will allow RBI to be non-committal on the future course of action, retaining the flexibility to react to the evolving inflation trajectory.”
The central bank also showed that it is keen on bringing transparency to lending in the market and also ensure that rate reductions are passed on to consumers.
“RBI’s decision to set up a high-level task force for creating a transparent, comprehensive and near-real-time public credit registry and comprehensive credit development reports by the credit information companies will help banks in credit assessment and risk pricing and make the credit market more efficient,” said ICICI Bank CEO Chanda Kochhar.