In its first bi-monthly monetary policy statement announced by RBI on April 7, there was no change in the policy repo rate (7.5%), CRR (4%), reverse repo rate (6.5%) and the marginal standing facility rate (at 8.5%).
This was not much of a surprise. In fact, the two cuts in the repo rate by 25 basis points each in January and March 2015 were considered a surprise by some stakeholders. Even earlier, RBI, under Governor Raghuram Rajan, came up with surprises.
During 2012-13, the real GDP growth was very low, at 4.5%, and the expectation for 2013-14 was also bleak. So, there was demand from the private sector for reduction in the repo rate. But inflation was a more serious problem—in September 2013, WPI was 7.1% and CPI at 9.8%. In October 2013, the repo rate was raised from 7.5% to 7.75%.
During October and November 2013, WPI was about the same as before, but CPI rose to 10.1% in October and 11.2% in November. The expectation was a further hike in the repo rate. But RBI surprised the markets by not changing the rates in its December 2013 announcement.
In December 2013, both WPI and CPI came down to 6.2% and 9.9%, respectively. The market expectation was a reduction in the repo rate or at least status quo, but the repo rate was raised to 8% in January 2014.
When asked whether RBI is ‘hawkish’, the Governor, quoting the Deputy Governor, said that RBI is nether ‘hawkish’ nor ‘dovish’, but ‘owlish’—i.e. it will keep a close watch and take appropriate action as and when necessary. He clarified that to control inflation, RBI will walk the talk from the demand side and urged the government to deal from the supply side. He suggested to the private sector to contribute to lowering inflation by improving efficiency and productivity.
With CPI at 9.9%, real interest rate was negative. Unless inflation comes down, deposit rates, and hence lending rates, can’t be brought down. He stated that when his predecessor lowered the repo rate, it did not result in lowering of lending rates by the banks.
RBI and the government
The situation during 2012-13 was similar. Growth rate was low and inflation high. Though the government and the industry were urging RBI to lower the repo rate, the then RBI Governor steadfastly held that inflation was a more serious problem and did not reduce the repo rate for quite some time. This prompted the then finance minister to comment that the government will walk alone.
Throughout 2014, RBI maintained the repo rate at 8%. With the change in the government, there were doubts about smooth relations between RBI and the finance ministry, but so far the relations have been smooth.
Monetary policy in 2015
As both WPI and CPI came down considerably in recent months, RBI has become more accommodative, reducing the repo rate by 25 basis points each in January and in March 2015, bringing it to 7.5%. The current monetary policy statement has given the following reasons for maintaining status quo in the rates:
- Unseasonal rains and hailstorms in March 2015, according to some estimates, may have affected as much as 17% of the sown area under rabi crop.
- The prices of protein-rich items such as pulses, meat, fish and milk kept food inflation high. Inflation expectations of households exhibit some firming up in response to turning up of food and fuel inflation.
- There are upside risks emanating from possible El Nino conditions leading to less than normal monsoons.
- Geo-political issues may lead to hardening of global commodity prices.
- The possibility that incoming data will provide more clarity on the balance of risks on inflation.
RBI and the banks
The latest policy statement mentioned one more reason for the status quo: transmission of policy rates to lending rates has not taken place despite front-loading of two rate cuts. When the RBI Governor exhorted that credit growth is tepid, banks were sitting on money and their marginal cost of funding has fallen, some public and private sector banks announced lowering of their base rates by 10-25 basis points.
RBI has announced that it would issue detailed guidelines to adopt marginal cost-of-funds approach in determining their base rates. Some banks have doubts about the usefulness of this approach. For example, according to SBI, the base rates could go up rather than going down if this approach is adopted. Further, banks contend that loan rates also depend on several other factors such as the deposit rates.
On CRR, too, there is some difference of opinion. Some banks want reduction and even abolition of CRR. RBI maintains that a 100 basis points reduction in CRR will only cause a 0.07 or 0.08 percentage point reduction in base rates, but releases R80,000 crore permanently into the system.
Issues such as these need to be thoroughly discussed on an ongoing basis, not just before or after the announcement of the monetary policy statement.
The author is visiting professor, GITAM School of International Business, Visakhapatnam