India makes surprise rate cut
Central bank moves in bid to tame inflation
MUMBAI: Reserve Bank of India governor Raghuram Rajan yesterday cut interest rates in an unscheduled move days after the government agreed for the first time to give the central bank a legal mandate to target inflation.
Mr Rajan, citing weakness in Asia’s third-largest economy, lowered the benchmark repurchase rate by a quarter percentage point to 7.5%, the second such move this year.
Economists at banks including Goldman Sachs had expected the bank to hold off until its next meeting on April 7.
India’s move is the latest salvo in an onslaught of global easing outside the US, with more than a dozen central banks adding stimulus so far this year. The decision also followed quickly on Prime Minister Narendra Modi’s agreement to a year-long quest by Mr Rajan for a focus on price stability in the nation with one of Asia’s fastest inflation rates.
“This makes explicit what was implicit before — that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way,” Mr Rajan said, referring to the monetary policy framework agreement unveiled on Monday.
The move took many economists by surprise.
“The only rational explanation is that they wanted to immediately reward the government for signing the monetary policy framework document,” said Dariusz Kowalczyk, an economist with Credit Agricole in Hong Kong. “I’m quite surprised by the fact they cut rates right after the budget. I thought the wider budget deficit would discourage them.”
Interest-rate swaps show that investors are betting that India will cut the benchmark rate by another 50 basis points by the end of 2015, the steepest decrease after Turkey among 14 emerging markets tracked by HSBC.
“It’s quite clear that India is an outlier in terms of high interest rates relative to the world,” Jayant Sinha, deputy finance minister, told reporters in New Delhi after the decision. “We have a set of circumstances that will guide you to believe that there will be an easing on the monetary side.”
Mr Rajan left rates unchanged last month after an unscheduled reduction in January. Consumer prices rose 5.11% in January, third fastest among 17 Asian economies tracked by Bloomberg, though below his 6% target for January 2016.
He said yesterday that inflation would stay below 6% in the second half of 2015, with risks including a rebound in oil prices, volatility from international financial markets and higher food costs due to a weak monsoon. The central bank will seek to bring inflation to the mid-point of the target of 4% plus or minus 2% by April 2018.
“Further monetary actions will be conditioned by incoming data, especially on the easing of supply constraints, improved availability of key inputs such as power, land, minerals and infrastructure, continuing progress on high-quality fiscal consolidation, the pass through of past rate cuts into lending rates, the monsoon out-turn and developments in the international environment,” Mr Rajan said.
Before the budget, Mr Rajan said would look for spending to shift towards supply-enhancing infrastructure. While the postponement of fiscal consolidation is a source for concern, the shift in funds to states and infrastructure projects helps mitigate the risks, he said yesterday.
“The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative,” Mr Rajan said. “Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation.”
Finance Minister Arun Jaitley said on Saturday that spending for roads, ports and bridges would rise 25%, largely funded by sale of stakes in state-run companies and market loans, while food and fertiliser subsidies are slated to rise. He also said the government would amend the central bank law to form a monetary policy committee.
“This shows that the government and RBI are on the same page in their assessment and outlook of the economy,” said Arvind Subramanian, the Finance Ministry’s chief economic adviser. “This is also a sign that the budget is conducive to noninflationary and durable growth.”
The inflation target, informally adopted by Mr Rajan after he became governor in September 2013, is the biggest revamp of the central bank’s mandate in its 79-year history. It reduces the risk that policymakers will abandon the overhaul in a nation dependent on oil imports where 59% of 1.2 billion people live on less than US$2 per day.
Mr Rajan said the agreement, along with signs of economic weakness, spurred him to move. He said the economy was “steadily recovering” even while forecast to grow by as much as 8.5% in the coming fiscal year, the fastest pace among major emerging markets.
“This could lead to a front-loading of cuts that could include another 25 basis points in April,” said Rupa Rege-Nitsure, an economist with L&T Finance. “I’d expect a hold with any further action being largely data dependent.”