RBI makes surprise rate cut

MUMBAI: The Reserve Bank of India surprised markets with a 25 basis point reduction in interest rates yesterday and signalled it could cut further, amid signs of cooling inflation and what it said was a government commitment to contain the fiscal deficit.

While the early move was unexpected, aggressive reductions in rates have been seen as likely over the course of the coming year to help India’s economy out of a rut, with growth rates struggling to recover from their weakest levels since the 1980s.

Tumbling oil prices and lower food costs have hardened speculation that more reductions in rates will follow, as recent data showed subdued consumer and wholesale price increases.

Acting ahead of a scheduled RBI policy meeting on Feb 3 and the government’s annual budget statement in late February, the RBI cut the repo rate — its key lending rate — to 7.75% from 8.0%, where it had been for the past year.

As a result, the reverse repo rate, the rate at which the central bank drains excess liquidity from the banking system, also moved down by 25 basis points to 6.75%.

“This demonstrates RBI’s confidence in the evolving inflation outlook and it shows that they are putting faith in government’s fiscal consolidation plan,” said Radhika Rao, economist at DBS Bank Ltd.

Investors saw RBI governor Raghuram Rajan putting India on a new easing cycle, as the former International Monetary Fund chief economist ordered his first rate cut since being appointed in August 2013.

Finance Minister Arun Jaitley, who earlier this week had said the time was right for lower rates, welcomed the cut and said it would help revive capital investments.

The early rate reduction now puts the onus on the government to make credible efforts to contain the fiscal deficit while pursuing policies aimed at boosting investment and improving infrastructure to fire up the economy.

In its statement, the RBI said “high quality” fiscal consolidation and reforms to power, land, minerals and infrastructure would be “critical” to more cuts.

Some analysts believe Rajan may have come under pressure from the government to lower interest rates sooner than he would have ideally chosen.

“This is a surprise move in the middle of the war on inflation,” said N.R. Bhanumurthy, a New Delhi-based economist at the National Institute of Public Finance and Policy.

“I am very surprised because it goes against the whole current governor’s philosophy that monetary policy should be predictable. It shows the governor is very pragmatic and can look at his own position and can change.”

Banks are likely to lower lending rates as a result of the RBI action, but company bosses warned a 25 basis point rate cut would not by itself get the economy growing, with many manufacturers running with high levels of spare capacity.

“The real effect at 25 bps is not going to be very much, however, it is the start of a cycle,” said VS Parthasarathy, chief financial officer at Mahindra & Mahindra Ltd, India’s top utility vehicle maker.

“Sometimes a stimulus is all about giving a cue... this is a cue.”