No change in repo rate for now, but room left for cuts in Sept
Even as he left key policy rate unchanged on Tuesday, Reserve Bank of India governor Raghuram Rajan used the occasion of the bimonthly credit policy to indicate that the RBI’s powers would not be diluted in the proposed monetary committee (MPC) and said the differences with the government on the composition and powers of the proposed MPC had been “overblown”. Though Rajan said it was best to wait for the government to announce the MPC, he suggested a great level of comfort between the government and RBI, saying that while the RBI Act gave the government the power to issue a directive to the central bank, this power had never once been used till date.
In response to a question on the MPC, Rajan chose to address the issue of a veto power for the RBI governor by saying, “If we retain the veto, it amounts to a status quo, since currently all advice given is just advice… That is something to be kept in mind.” When the issue of the composition of the committee came up again, Rajan referred — without comment — to an article written by a former finance minister. The article in question, by P Chidambaram in The Financial Express, had plumped for a six-member MPC, equally divided into RBI and government nominees, with the casting vote with the governor in case of a tie to “put the onus squarely upon him”.
On the issue of proposed inflation targets being reviewed every three years, Rajan said, “We’re not saying targets should be fixed for an eternity.” At a hastily-called press conference on Monday, finance secretary Rajiv Mehrishi had attempted to downplay the contents of the draft Indian Financial Code, saying there was no intention of diminishing the RBI’s role. Minister of state for finance Jayant Sinha too had clarified earlier that these were merely “inputs”.
Meanwhile, the central bank left the repo rate unchanged at 7.25%, observing it would track data and developments for any “emerging room for more accommodation”. However, monetary policy, the central bank noted, would be conditioned, inter alia, by a “fuller transmission” by banks of previous cuts in policy rates. Rajan pointed out the 75 basis points cut in the repo rate since January had been followed up with “just a fraction” of a cut in the median base lending rates of banks of 30 basis points but said there could be some transmission over the next few months.
Banks, for their part, were non-committal on any cuts in their loan rates. Without committing to any cuts in lending rates, Pradeep Kumar, managing director, State Bank of India (SBI), said as deposits got repriced and the cost of deposits trended down, banks would be able to pass on the reduced base rates to the borrowers. Kumar pointed out that unfortunately, in a falling interest rate scenario, depositors were moving money from CASA to term deposits, expecting a fall in rates.
“If food and core prices remain soft over the next few months, global commodity prices stabilise at low levels and Fed action does not pose a meaningful worry, space for a final 25bp rate cut could open up. However, the possibility of doing any more is constrained by the challenging target of 4% CPI by 2018,” economists at HSBC wrote after the policy announcement.
Economic recovery, the central bank said, remained “work in progress”, adding that the RBI’s surveys pointed to flat capacity utilisation and new orders. Expressing concern on the uptick of prices other than food and fuel, the central bank left the target inflation for January 2016 unchanged at 6% while lowering inflation for the January-March quarter by 20 basis points.
Rajan observed real interests were in the region of 1.5%, pointing out that the risk premium being paid by borrowers could not constitute part of the rate. He argued that unless depositors earned a decent return on their money, there would not be adequate savings to finance investment.
While referring to stressed sectors such as steel, the governor asserted it was important to ensure that operating losses of the discoms of state electricity boards were cut back. “The FRP and forbearance haven’t worked and the problem has to be dealt with action upfront. It has to be understood that this is not tenable,” Rajan said.
Monetary Policy Committee
* Under RBI Act, govt can give a directive to RBI, but has never done so till date
* If RBI is given a veto, this won’t be new as that is the position right now
* Refers to column by P Chidambaram where former FM suggests equal RBI and govt members with casting vote for governor
* No change for now, waiting to see how monsoon plays out and also whether Fed raises rates
* Leaves room for further cuts, says inflation risk is ‘balanced’ on Tuesday as against ‘upside risk’ in June policy statement