A change of guard at the Reserve Bank of India (RBI) has brought with a it a softer stance. The RBI on Tuesday cut the key repo rate by 25 basis points to 6.25%, the lowest level in six years, despite pointing out upward risks to inflation.
While banks are unlikely to lower their base rates immediately, the MCLR (marginal cost of funds lending rate — is expected to come down.
The cut in the repo despite caution on upside risks to inflation was interpreted by economists and markets alike to mean the RBI would be far more flexible in its approach to monetary policy. Many believe there is another rate cut of 25 basis points round the corner.
Governor Urjit Patel told at a media conference the monetary policy committee would be guided by the consumer inflation band of 4% plus or minus 2% while framing policy. “The ad hoc measures have been superseded by the amendments to the RBI Act,” Patel observed.
Bond markets were also enthused by the RBI’s acceptance of a lower real neutral rate against the backdrop of falling neutral rates globally. The central bank observed on Tuesday that the appropriate neutral real rate for India has fallen to 1.25% from 1.5-2% previously. This, experts, point out, would give the RBI more room to cut rates.
Bonds rallied smartly with the yield on the benchmark falling 4 basis points to 6.73%. Treasurers pencil in another 25 bps cut by March end and see the yield headed closer to to 4.5%, given liquidity is adequate and the central bank has promised it would stay that way.
Sonal Varma, economist at Nomura, said that despite pointing out upside risks to inflation, the RBI has trimmed the repo and changed its stance on real rates, suggesting that the tenets of the flexible inflation targeting framework, as interpreted by the previous RBI governor, Raghuram Rajan, and the current governor “have implicitly changed”.
Meanwhile, bankers were unwilling to give firm timelines for rate cuts. B Sriram, managing director, State Bank of India, said that any benefits of a lower cost of funds would flow to customers every month via the MCLR.
“We don’t need to wait too long to take a decision so there could be a cut next month,” Sriram said. However, he ruled out a cut in the base rate, explaining that those who wanted to get the benefit of a lower interest rate could shift to the MCLR.
Srinivasan Varadarajan, deputy managing director, Axis Bank, said that while a cut in the base rate could take longer than that for an MCLR cut, it should come down. “We will review it and it should come down,” Srinivasan said.
Keki Mistry, vice-chairman and CEO, HDFC, noted that even though the incremental cost of funds may have come down, it would take more time for it to get transmitted to lower lending rates. “We could hope to see lower rates in the not too distant future,” Mistry added.
The RBI left its baseline CPI projection unchanged at 5% for March 2017, with risks “titled to the upside, albeit lower than in June and August”. The central bank now sees CPI inflation at 4.5% by Q4 2018, up from the April projection of 4.2% with an upside risk.
The RBI left the projection for GVA growth in FY17 unchanged at 7.6%. It expects GVA growth to recover to 7.9% in FY18, but with downside risks due to weaker global demand.