Five days after the presentation of the Union Budget 2015, the Governor Raghuram Rajan-led Reserve Bank of India (RBI) on Wednesday unexpectedly cut the policy Repo rate by 25 basis points as “disinflation is evolving along the path set out by the RBI at a faster pace than earlier envisaged”.
With this, the RBI has cut repo rate, the rate at which the RBI lends funds to the banks, by 50 basis points to 7.50 per cent in calendar 2015.
On January 15, the RBI reduced the policy repo rate by 25 basis points and indicated that “key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation…”
The latest cut buoyed the stock markets and the Sensex soared to the historic 30,000-mark. The 30-share index was trading by over 282 points to 29,876 at 10.20 am IST.
Dipen Shah, Head- Private Client Group Research, Kotak Securities
RBI cut policy rates today by 25 bps, following 25 bps cut in Jan policy. RBI surprised by announcing rate cut on inter-policy date, effectively making next policy date redundant. RBI had indicated in Feb policy that it would wait for fiscal consolidation and re-based CPI inflation, both of which helped in creating favorable environment. Although, we were expecting 25 bps rate cut in April policy timing is certainly a surprise. We expect RBI to be on hold now in April 7th policy.
RBI Governor Raghuram Rajan had last month indicated that the RBI will keenly monitor the revision in the consumer price index (CPI) with regard to the path of inflation in 2015-16 as well as the Union Budget for 2015-16. Inflation in January 2015 at 5.1 per cent as measured by the new index was well within the target of 8 per cent for January 2015.The RBI which was closely watching the fiscal situation of the government waited for clues from the Budget for the latest rate cut.
Incidentally, both Minister of State (MoS) for Finance Jayant Sinha and Chief Economic Adviser Arvind Subramanian had recently said the situation as being ripe for an interest rate cut by the RBI. Former Finance Minister Yashwant Sinha had also proposed a sharp cut in rates to boost investments and kick-start the growth.
In a recent interview to The Indian Express, ICICI Bank Chairman KV Kamath had said interest rates in India need to be cut by at least two per cent or 200 basis points over the next 12 months or so, for growth to rebound as such a deep correction will act like a “magic and tonic” to the efforts that the government is taking to put the economy back on track besides repairing corporate and bank balance sheets.
Kamath’s argument is based on his experience of 2001, when the NDA government led by Vajpayee and with Yashwant Sinha as finance minister slashed administered interest rates sharply, which provided a momentum to growth a few quarters down the line.
During that period, home loans rates dropped from a peak of 15 % to 7.5 % besides a steep slide in bond prices — all of which provided the required momentum for growth subsequently. “Then you had the magic of the economy starting to move. If you want to see growth come back to the momentum and retail consumers to be the engine of that momentum, interest rates have to come down by two per cent in the next 12 months or so, Some steps have been taken by the government and some will be in the budgetary process,” Kamath said.
Statement by RBI Governor Raghuram Rajan on repo rate cut
It may be recalled that in its statement on monetary policy of January 15, 2015 the Reserve Bank reduced the policy repo rate by 25 basis points and indicated that ““Key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation…”.While maintaining the interest rate stance in its sixth bi-monthly monetary policy statement of February 3 in the absence of new developments on inflation or on the fiscal outlook till then, the Reserve Bank indicated that it will keenly monitor the revision in the consumer price index (CPI) with regard to the path of inflation in 2015-16 as well as the Union Budget for 2015-16.
The new CPI rebased to 2012 was released on February 12, 2015. Inflation in January 2015 at 5.1 per cent as measured by the new index was well within the target of 8 per cent for January 2015. Prices of vegetables declined and, hearteningly, inflation excluding food and fuel moderated in a broad-based manner to a new low. Thus, disinflation is evolving along the path set out by the Reserve Bank in January 2014 and, in fact, at a faster pace than earlier envisaged.
The uncertainties surrounding any inflation projection are, however, not insignificant. Oil prices have firmed up in recent weeks, and significant further strengthening, perhaps as a result of unanticipated geo-political events, will alter the inflation outlook. Other international commodity prices are expected to remain benign, given still-sluggish global demand conditions. Food prices will be affected by the seasonal upturn that typically occurs ahead of the south-west monsoon and, therefore, steps the government takes on food management will be critical in determining the inflation outlook. Finally, the possible spill over of volatility from international financial markets through exchange rate and asset prices channels is also still a significant risk.
Perhaps the most significant influences on near-term inflation will be the strength of aggregate demand relative to available capacity. Two recent developments pertaining to the demand-supply balance are the recently-released GDP estimates and the Union Budget for 2015-16.
The Central Statistical Organisation is to be commended on the changes it has made to the methodology of estimating GDP, bringing India up to international best practice. Yet the picture it presents of a robust economy, with growth having picked up significantly over the last three years, is at odds with still-low direct measures of growth of production, credit, imports and capacity utilisation as well as with anecdotal evidence on the state of the economic cycle. Nevertheless, the picture of a steadily recovering economy appears right.
The fiscal impulses in the Union Budget then assume importance. There are many important and valuable structural reforms embedded in this Budget, which will help improve supply over the medium term. In the short run, however, the postponement of fiscal consolidation to the 3 per cent target by one year will add to aggregate demand. At a time of accelerating economic recovery, this is, prima facie, a source for concern from the standpoint of aggregate demand management, especially with large borrowings intended for public sector enterprises.
Some factors mitigate the concern. The government has emphasized its desire to clean up legacy issues which gave a misleading picture of the true extent of fiscal rectitude, and has also moderated the optimism in its projections. To this extent, the true quantum of fiscal consolidation may be higher than in the headline numbers. Also, the government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower. Furthermore, supported by lower international energy prices, there is a welcome intent to shift from spending on subsidies to spending on infrastructure, and to better target and further reduce subsidies through direct transfers. Finally, the central government has signed a memorandum with the Reserve Bank setting out clear inflation objectives for the latter. 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. In sum, then, the government intends to compensate for the delay in fiscal consolidation with a commitment to an improvement in the quality of adjustment.
Of course, all these mitigating factors have a fair component of intent. The realised net fiscal impulse will depend on both central and state government actions going forward.
Finally, the rupee has remained strong relative to peer countries. While an excessively strong rupee is undesirable, it too creates disinflationary impulses. It bears repeating here that the Reserve Bank does not target a level for the exchange rate, nor does it have an overall target for foreign exchange reserves. It does intervene on occasion, in both directions, to reduce avoidable volatility in the exchange rate. Any reserve build-up is a residual consequence of such actions rather than a direct objective.
To summarise, softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6 per cent in the second half. The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative. 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.
Consequently, it has been decided to:
* reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 per cent to 7.5 per cent with immediate effect;
* keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL);
* continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity under 7-day and 14-day term repos of up to 0.75 per cent of NDTL of the banking system through auctions; and
continue with daily variable rate repos and reverse repos to smooth liquidity.
Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 8.5 per cent with immediate effect.
The need to act outside the policy review cycle is prompted by two factors: First, while the next bi-monthly policy statement will be issued on April 7, 2015 the still weak state of certain sectors of the economy as well as the global trend towards easing suggests that any policy action should be anticipatory once sufficient data support the policy stance. Second, with the release of the agreement on the monetary policy framework, it is appropriate for the Reserve Bank to offer guidance on how it will implement the mandate.
Going forward, the RBI will seek to bring the inflation rate to the mid-point of the band of 4 +/- 2 per cent provided for in the agreement, i.e., to 4 per cent by the end of a two year period starting fiscal year 2016-17.
The guidance on policy action given in the fifth-bi-monthly monetary policy statement of December 2014 is largely unchanged. 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 outturn and developments in the international environment.
Reserve Bank of India (RBI) lowers policy repo rate by 25 basis points to 7.5 per cent
(Reuters) The Reserve Bank of India (RBI) today lowered its policy repo rate by 25 basis points to 7.5 per cent on Wednesday, its second inter-meeting cut this year on the back of easing inflation and what it said was “weak state” of parts of the economy.
“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,” Reserve Bank of India Governor Raghuram Rajan said in a statement.
The RBI rate cut comes just days after the Narendra Modi government and the Reserve Bank of India agreed to formally adopt inflation targeting, though the central bank introduced its own targets a year ago.
Analysts said the RBI’s rate cut appeared to give a seal of approval for the government 2015/16 budget, and its pledge to exercise fiscal responsibility, while taking an additional year to meet a fiscal deficit target of 3 percent of gross domestic product.
“Softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6 percent in the second half. The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative,” Rajan said.
The statement noted that the rupee’s relative strength also added to disinflationary pressures, although Rajan said the RBI does not target exchange rates and does not have a target for currency reserves.
Indian inflation has moderated sharply as oil prices slumped since last year. In January, consumer prices INCPIY=ECI rose an annual 5.11 percent, well within the inflation target agreed by the government and RBI.
In a document dated Feb. 20 but published on the ministry website on Monday, both sides agreed to set a consumer inflation target of 4 percent, with a band of plus or minus 2 percentage points, from the financial year ending in March 2017.
The RBI had first lowered interest rates this year on Jan. 15, in a similarly unexpected move. Both rate cuts took place outside of the central bank’s scheduled policy review meetings.
RBI rate cut: Views
The Reserve Bank of India cut its repo interest rate by 25 basis points to 7.5 per cent on Wednesday, in its second move this year outside official policy meetings.
ABHEEK BARUA, CHIEF ECONOMIST, HDFC BANK, NEW DELHI:
“I am a little surprised that they did it today because I think they just sort of followed up on the January precedent and did it out of the policy, which I don’t think is necessarily a good thing. It introduces a lot more volatility in the markets, than when the rate cuts were coming on a formal platform.
I think that’s something I would warn against.
Now the rate cut is working in favour of markets, but you could potentially have a situation where there is positive data, and he doesn’t follow up with an immediate cut. The market might sell off. So you’re sort of building a lot of expectation around a very reactive policy, which I don’t think is a good thing.
It was a response to the consolidation and a recognition that he’s happy with it. I think he’s assuaged certain concerns that were emerging that he would be a little slower on policy.
We had said 3 cuts this year. We might see another 50-75 basis points.”
SHUBHADA RAO, CHIEF ECONOMIST, YES BANK, MUMBAI:
“There was a growing concern particularly in the recent data from the core sector (core industries) and PMI, and both seemed to be suggesting some deceleration in growth.
More importantly, in the backdrop, the comfort lies in inflation. We see inflation undershooting (the RBI target) by 60 basis points. We could see inflation at 5.4 percent. Now if that is the kind of expectation on inflation, and particularly if they are trying to revive growth, then we think RBI therefore gets some comfort.
We are not sure now of another cut in April. We still believe there is room for rate cut, by another 25-50 bps.”
M.S. RAGHAVAN, CHAIRMAN, IDBI BANK, MUMBAI:
“It is a very good sign.
It’s a very simple arithmetic that the rate cycle has reversed. If not today, tomorrow (bank interest) rate has to come down.
“(The RBI) also know that the rate cut they are announcing gets actual benefits accrued to the banks with a lag of at least 4-5 months. The first rate cut benefit should come very soon.
“Probably by end of March all will decide as to what to do and then (the rate cut) will be passed on.”
FREDERIC NEUMANN, CO-HEAD OF ASIAN ECONOMICS AT HSBC IN SINGAPORE:
“Exciting morning! It looks like the RBI feels reassured by the budget proposals. The budget is going in the right direction with greater spending on infrastructure, something that the RBI has sought.
With the budget out of the way the road is clear for a series of rate cuts. It is somewhat surprising that they are doing it off-meeting. Governor Rajan seems to be a friend of surprises.
We expect one more rate cut (this year) but it looks as though the bias is towards more easing. One more is in the bag. The formal adoption of inflation targeting could potentially restrain more aggressive easing later on as the RBI tries to hit its 6 percent target by next January.”
SAUGATA BHATTACHARYA, CHIEF ECONOMIST, AXIS BANK, MUMBAI
“It looks like the RBI wants monetary policy transmission and by cutting rates offcycle they are trying to push transmission proactively.
The combination of lower inflationary pressures, fiscal consolidation roadmap, rationalisation of expenditure has prompted RBI to cut rates in an offcycle move.”
KILLOL PANDYA, SENIOR FUND MANAGER, LIC NOMURA MF ASSET MANAGEMENT, MUMBAI
“Rajan has re-inforced his power to cut rates outside the policy, a second time. I tip my hat to him for that. Rate cut was necessary, we were expecting it to happen sometime this financial year. We were hoping RBI to wait for the inflation data but today’s cut has come as a pleasant surprise.
“I feel the April policy will be a non-event from the rate-cut perspective, next on watch will be June policy. Bonds could see a considerable rally post the cut today. Bonds are expected to retrace earlier losses and inch up further.”
RUPA REGE NITSURE, GROUP CHIEF ECONOMIST AT L&T FINANCIAL SERVICES, MUMBAI
“This was along expected lines. They had said the next cut is contingent on the quality of fiscal adjustment. And govt has indeed paid attention to the quality of fiscal adjustment
Aggressive rate cuts are not possible in this year because they have already signed the MoU with the RBI on flexible inflation targeting. And inflation is at the mid point level. I feel another 25 bps is possible, maybe in the April policy but after that there will be a pause.”
RADHIKA RAO, ECONOMIST, DBS, SINGAPORE
“I think the inter-meeting rate cut is a positive surpirse on timing. By this I think the Reserve Bank of India is expressing its confidence on inflation outlook.
This also means that despite higher fiscal deficit the quality of fiscal consolidation has satisfied central bank’s expectations.”
A PRASANNA, ECONOMIST, ICICI SECURITIES PRIMARY DEALERSHIP LTD, MUMBAI
“It is a surprise. Looks like RBI was happy with budget but also raises question why RBI did not wait for its scheduled meeting date.”
ANEESH SRIVASTAVA, CHIEF INVESTMENT OFFICER, IDBI FEDERAL LIFE INSURANCE, MUMBAI
“The only surprise that I see is that the rate cut is coming immediately after budget. The quality of the deficit is improving, hence there was scope to cut rates. Domestically macroeconomic data is not giving much comfort and also our rival countries have reduced interest rates.
The reality is growth is yet to pick and it is a right move on the part of the RBI. We still expect another 25 basis points cut in next 3-6 months time. Only caveat is what would happen when Fed starts raising rates.”
MOHIT GOEL, CEO, OMAXE LTD
“On the back of Budget, the cut in rep rate by 25bps to 7.5% is a quick move by the Reserve Bank of India to make every attempt to lower the cost of financing and spur demand in the economy. With two cuts in a span of 1.5 months, the apex bank has given the right signals and it’s time banks reciprocated. The impact of the cut has already been felt in the market with Sensex scaling 30k mark; and this reduction will boost the morale of consumers, investors and India inc. It is indeed a good and positive step for the economy.”
AMIT MODI, DIRECTOR, ABA CORP
“This is a good and much awaited development, since easing interest rate will help revive health of businesses like real estate which are highly sensitive to interest rate movements, but while it is indeed a step in the right direction, 25 basis points cut may not be enough to spur the investment cycle, there is definitely more required, and lending rates will have to further come down by at least one or two percentage points to improve the general sentiment towards investments in the country. We sincerely hope that unlike the last time, this time both Finance Ministry as well as the RBI asks all the Banks to transfer the benefits to the end consumer, else this move will severely stop short of benefiting the consumer.”
BROTIN BANERJEE, MD AND CEO TATA HOUSING
“The rate cuts announced by RBI, bringing the repo rate down to 7.5% from the earlier 7.75% , is a welcome move and it can contribute positively to the growth of the real estate sector. The rate cuts announced in January had not translated into action by the banks, but a cumulative cut now amounting to 0.5% will enhance lending powers of the banks. It will permit banks to cut down interest rates on home loans enabling new consumers to take advantage of the low interest rates in the real estate market. We are however hopeful that given the positive sentiment of the budget and the economy a further cut in rates to be announced later this year”.
GEORGE ALEXANDER MUTHOOT, MANAGING DIRECTOR, MUTHOOT FINANCE LTD
“The day could not have started better with the RBI’s surprise round of rate cuts. An excellent budget followed by rate cuts, it seems the government and the regulator are perfectly synced for stimulating economic growth. It was a long standing demand of corporate India to reduce the cost of borrowing and it is comforting to see that we are steadily moving towards it. I expect the banks should follow the suite and reduce their base rates as well thereby making funds cheaper.”