The 25-basis-points cut in the repo rate on Tuesday, to a six-year low of 6.25%, will no doubt cheer the markets. But what they should cheer more is the perceptible shift in RBI Governor Urjit Patel’s stance to one which now sounds more accommodative than under his predecessor, Raghuram Rajan. The dramatic fall in inflation would, it is true, have warranted a rate-cut anyway, but RBI’s new stance makes room for future rate-cuts even if there is an upside risk to inflation, such as from a higher GST rate or the secondary impact of the Pay Commission award being implemented. To be sure, RBI is stuck with inflation-targetting, ironically something recommended by the Patel committee in the past, but Patel plans on being more flexible now that he is Governor. So when asked, at the customary post-policy press conference, if he would stick to the 4% CPI level targeted by RBI in the past, he said the earlier RBI ad hoc measures had now been replaced by a monetary policy framework—and that clearly gives a CPI range that, from 2%, goes all the way to 6%.
And while Patel’s predecessor had spoken, in the past, of the need to have a 1.5-2 percentage point real interest rate corridor, on Tuesday, RBI said a 1.25% corridor was more appropriate in the current global context. That may sound like Patel is more dovish than Rajan, but to use an earlier phrase of his, he is being more owl-like. The current investment weakness, the monetary policy report says, poses a risk to the economy’s potential output and could even be impairing productivity; in such a situation, inflation-control has to be more carefully calibrated and the central bank needs to look at the larger interest of the economy.
Being able to stimulate demand, of course, will depend upon whether Tuesday’s rate cut will be passed on by banks, and that is unclear. The fact that wholesale money will become a bit cheaper, especially if inflation is expected to soften further, should give bankers some room to cut lending rates. However, lenders remain reluctant to cut the base rate, to which most borrowers are currently linked, because they fear it would hit their margins. That is unfortunate because, with lower inflation resulting in real rates on deposits becoming even more positive, banks can afford to cut them—to that extent, the cost of funds will not go up. In fact, the fall in the MCLR—marginal cost of funds rate—too has not been meaningful so far. In short, there has been limited transmission via the banking system and though borrowing costs in the bond and money markets have come off sharply, that only helps the better-rated companies who can access these markets. While lower interest rates cannot in themselves kickstart investment and capital expenditure, they could ease the cash-flows of a large number of smaller companies. But until the lower policy rates translate in lower lending rates, of course, there is little to celebrate.