Raghuram Rajan’s RBI surprises with 25 bps repo rate cut to 7.75 pct

By: | Updated: January 15, 2015 9:31 PM

RBI surprises the market by cutting its benchmark repo rate by 25 basis points

RBI rate cut, Raghuram RajanOn current policy settings, inflation is likely to be below 6 per cent by January 2016, says RBI Governor Raghuram Rajan. RBI has cut the repo rate by 25 basis points to 7.75 per cent, signalling a major shift in its monetary policy stance. (Reuters)

In a pleasant surprise, Governor Raghuram Rajan-led Reserve Bank of India (RBI) today cut its policy rate by 0.25 per cent in the first reduction in 20 months and promised more, paving way for cheaper home and auto loans as also lower cost of funds for corporate borrowers.

While the government, industry and stock markets cheered RBI’s much-awaited move, state-owned Union Bank and United Bank within hours lowered their respective benchmark lending rates by similar margin, giving relief to borrowers.

Others, including the PSU giant SBI and private sector major ICICI Bank indicated they will look at rate cuts soon to pass on the benefit to their customers from RBI’s lowering of repo rate, at which banks borrow from the central bank.

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“Reduction in the rates is a positive development. It will lead to more money in the hand of the consumers and greater spending. It’s positive for the Indian economy,” said Finance Minister Arun Jaitley, who has been nudging RBI for a rate cut for months now.

The industry has also been demanding an interest rate cut to lower their cost of capital and help revive the investment cycle.

Jaitley said that the RBI decision would “certainly help in reviving investment cycle that the government is trying to restore”.

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The Reserve Bank cut the repo rate by 25 basis points to 7.75 per cent with immediate effect, cheering the stock markets where the benchmark sensex soared by 847 points to 28,194 points during the intra-day trade.

RBI had last reduced the repo rate on May, 3, 2013, when it was lowered from 7.5 per cent to 7.25 per cent. Thereafter, the rates went higher and had remained steady at an elevated level of 8 per cent since January 2014.

RBI Governor Raghuram Rajan, who had been maintaining a hawkish stance till now, decided to go in for rate cut a fortnight ahead of the scheduled date of announcement of monetary policy review on February 3.

The surprise early morning move, before the markets opened, came amid softening inflation levels and a reiteration by the Finance Ministry to stick to its fiscal deficit target of 4.1 per cent for the current financial year.

Commenting on the rate cut, SBI Chairman Arundhati Bhattacharya said the country’s largest lender “will look at how and when base (lending) rates can be cut”, while ICICI Bank CEO Chanda Kochhar said that the much-awaited lowering of lending and deposit rates would definitely take place now.

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Check out the reactions to the poll on RBI rate cut we asked on January 14, 2015:

As a result of the rate cut, the reverse repo rate, the rate at which the central bank drains excess liquidity from the banking system, also moved down by 25 basis points to 6.75 per cent.

The RBI, however, has decided to keep the cash reserve ratio (CRR), the portion of deposits which the banks are required to have in cash with the central bank, unchanged at 4.0 per cent.

Rajan had during the previous monetary policy review on December 2 hinted at a possible easing in rates early in 2015, including outside of planned meetings.

Elaborating on the price situation, a RBI statement said “inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015. On current policy settings, inflation is likely to be below 6 per cent by January 2016.”

Lower-than-expected inflation has been enabled by decline in prices of vegetables and fruits, cereals and the large fall in international commodity prices, particularly crude oil, it said, adding barring geo-political shocks, they are expected to remain low over the year.

Welcoming the rate cut, Ficci President Jyotsna Suri said, “this measure will help in improving the investor sentiment. Ficci hopes that this will be the beginning of further cuts in the policy rate by the central bank, and will enable its transmission into lower lending rates by the banks.”

CII Director General Chandrajit Banerjee said that the reduction in repo rate has come as a positive surprise in the new year and would be a huge mood lifter for investors who have been grappling with subdued demand conditions.

Automobile manufacturers, however, were not too happy with the 25 basis points rate cut saying it was “too little, too late”.

According to General Motors India India Vice-President P Balendran: “While this is definitely a welcome move, but it is too little too late. We were expecting a rate cut of 50 basis points.”


Since July 2014, inflationary pressures (measured by changes in the consumer price index) have been easing. The path of inflation, while below the expected trajectory, has been consistent with the assessment of the balance of risks in the Reserve Bank’s bi-monthly monetary policy statements. To some extent, lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil. Crude prices, barring geo-political shocks, are expected to remain low over the year. Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December. Finally, the government has reiterated its commitment to adhering to its fiscal deficit target.

These factors have significantly reduced the momentum of inflation, compensating for the widely anticipated ending of favourable base effects. Households’ inflation expectations have adapted, and both near-term and longer-term inflation expectations have eased to single digits for the first time since September 2009. Inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015. On current policy settings, inflation is likely to be below 6 per cent by January 2016.

These developments have provided headroom for a shift in the monetary policy stance. It may be recalled that the fifth bi-monthly monetary policy statement of December had stated that “if the current inflation momentum and changes in inflation expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle”. In its public interactions, the RBI had committed to initiate the process of monetary easing as soon as data indicated that medium term inflationary targets would be met. Keeping this commitment in mind, it has been decided to:

*   reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 per cent to 7.75 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 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 8.75 per cent with immediate effect.

The fifth bi-monthly monetary policy statement also stated that once the monetary policy stance shifts, subsequent policy actions will be consistent with this stance. Key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation as well as steps to overcome supply constraints and assure availability of key inputs such as power, land, minerals and infrastructure. The latter would be needed to ensure that potential output rises above the projected pick-up in growth in coming quarters so as to contain inflation.

In pics: Check out what happened last month when Raghuram Rajan refused to cut rates

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