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Business News/ Politics / Policy/  RBI keeps the door open on rate cuts
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RBI keeps the door open on rate cuts

Central bank leaves key rates unchanged, says the outlook for economic growth is improving gradually

RBI governor Raghuram Rajan says rates will eventually have to come down and that may happen after September. Photo: BloombergPremium
RBI governor Raghuram Rajan says rates will eventually have to come down and that may happen after September. Photo: Bloomberg

Mumbai: The policy rate will fall. There will be a dip in inflation. And an economic recovery may be on the horizon.

That was the between-the-lines message from the Reserve Bank of India’s (RBI’s) bi-monthly monetary policy review, in which the central bank stuck to the script and changed nothing.

Following Tuesday’s policy, RBI’s policy rate, at which it lends funds to commercial banks, stands at 7.25%. Since the start of the year, rates have been reduced by 75 basis points. One basis point is one-hundredth of a percentage point.

The cash reserve ratio (CRR), or the proportion of deposits banks have to hold as cash with RBI, remains at 4% and the statutory liquidity ratio (SLR), or the proportion of deposits banks have to hold in liquid instruments (gold, cash, government bonds), at 21.5%.

Still, RBI’s statement indicated that it was willing to consider more rate cuts.

“As the Reserve Bank awaits greater transmission of its front-loaded past actions, it will monitor developments for emerging room for more accommodation," the central bank said in its policy statement, clearly indicating that rate cuts are not ruled out.

Soon after the policy was announced, Delhi-based Oriental Bank of Commerce reduced rates in two of its short-term deposit baskets by 25 basis points each. The bank did not cut its lending rate.

State Bank of India chairperson Arundhati Bhattacharya ruled out rate cuts in the immediate future. In an interview with television channel ET Now, she said future rate cuts will depend on a revival in economic growth and credit growth, and the bank’s ability to make profits from treasury operations and the like so as to pass on a rate benefit to its customers.

ICICI Bank Ltd’s managing director and chief executive officer (MD and CEO) Chanda Kochhar said she expects “to see easing of rates over a period of time as further transmission of accommodative monetary policy takes place". The bank did not lower its rates either.

Bank of Baroda’s MD and CEO Ranjan Dhawan had said earlier that the bank would not lower lending rates in a hurry, but would eventually cut rates as and when the bank’s cost of funds comes down.

There is a good agreement in place between the RBI and the government which represents all the necessary requirements of a good monetary policy committee (MPC). I don’t think there is anything for anyone to worry about.- Raghuram Rajan on MPC

RBI governor Raghuram Rajan once again chided banks for not lowering their lending rates, but he also acknowledged that transmission takes time.

In a post-policy interaction with the media, Rajan said rates will eventually have to come down and that may happen after September. Meanwhile, the money market has carried the transmission in a far more effective manner than the banking channel, he said.

“Transmission takes place over time. What is important to remember is that monetary policy is not like a lever you press and then you get immediate action. It is about three-four quarter lag between when the rates are cut and when the effects are seen in the economy," Rajan said, adding that the full impact of RBI’s previous rate cuts can be seen only after September.

“We have to forecast what is going to happen in the economy three-four quarters down the line, not what is happening currently. We are fully cognizant of the fact that transmission takes place slowly. What the rate action does is give a signal, that signal then gets turned into plans, which then fructify down the line and turn into activity," Rajan said.

The outlook for growth is improving gradually. On an assessment of the evolving balance of risks, the projected output growth for 2015-16 has been retained at 7.6%. However, there are signs that consumption demand, especially in urban areas, is picking up.- Raghuram Rajan on growth

In its policy statement, RBI noted that relative to the projections in the June policy, “inflation projections in this bi-monthly statement are elevated by the higher-than-expected June observation but reduced by prospects of softer crude prices and a near-normal monsoon thus far".

“Taking into account all this, and given that policy action was front-loaded in June, it is prudent to keep the policy rate unchanged at the current juncture while maintaining the accommodative stance of monetary policy."

In a conference call with analysts, Rajan said inflation is low but needs to be brought down once and for all.

“We must take advantage of the circumstances to bring inflation down once and for all and it is at a mild cost to output. If we can bring down inflation with only a mild cost to output we would have done an extremely good favour to the economy," Rajan told analysts, adding that the central bank plans to move to project inflation for 2017 projection “pretty soon".

Monetary policy is not like a lever you press and then you get immediate action. It is about three-four quarter lag between when the rates are cut and when the effects are seen in the economy. We started cutting rates in January and I expect to see the effects only after September.- Raghuram Rajan on transmission of monetary policy

Indian households expect prices to remain stable or even fall in the next three months and the next one year, RBI’s inflation expectation survey found. However, the proportion of respondents expecting prices to rise has increased from the previous surveys, RBI said in a separate statement.

Consumer price inflation rose to 5.4% in June from 5.01% in May.

According to Rajan, the front loading of rates was a necessity, but he did not rule out further rate cuts, even outside the policy review.

Banks’ mandatory bond holding limit, or SLR, will eventually come down too, the governor said. However, he did not commit to a time-frame for this.

We must take advantage of the circumstances to bring inflation down once and for all and it is at a mild cost to output. If we can bring down inflation with only a mild cost to output we would have done an extremely good favour to the economy.- Raghuram Rajan on inflation

Soon after the RBI announcement, the yield on the 10-year benchmark bond rose to 7.797% from 7.788% before the policy. Bond prices and yields move in opposite directions.

The 10-year benchmark bond yield closed at 7.84%. The rupee closed at 63.75 a dollar compared with 63.99 before the policy announcement.

India’s benchmark Sensex closed down 0.41%, or 115.13 points, at 28,071.93 points.

While the status quo was on expected lines, industry lobby group Confederation of Indian Industry said RBI should have cut rates as that would have sent a strong signal that the central bank is aggressively addressing growth risks in the economy.

However, RBI sees some pick-up in growth already.

“The outlook for growth is improving gradually. Favourable real income effects could accrue from weaker commodity prices, in particular crude oil, and a possible step-up in agricultural activity if monsoon conditions continue to improve," RBI said, but it also warned that export contraction, owing to slowdown in global growth, could become a prolonged drag on growth.

“Notwithstanding some improvement in the state of stalled projects, supply constraints continue to be binding and new investment demand emanating from the private sector and the central government remains subdued," RBI said, retaining its economic growth forecast for the current year at 7.6%.

Professional forecasters polled by RBI expect economic growth in 2015-16 to be 7.6%, down 0.2% from the previous round. Their growth rate expectations for 2016-17 remained unchanged at 8.2%.

RBI noted that demand, particularly in the urban areas, is inching up and credit availability is adequate, but economic recovery is still a work in progress.

The monsoon is near normal and higher reservoir levels augur well for the prospects of the monsoon crop, particularly in areas that are dependent on irrigation.

“If prospects of a good harvest strengthen, currently weak rural demand will improve to provide an important boost to activity."

Economists said there was very little scope for the central bank to reduce rates and the status quo was on expected lines. There could be room for another 25 basis points cut in the policy rate but beyond that it may be a struggle for the central bank to ease borrowing costs. One basis point is one-hundredth of a percentage point. “If food and core prices remain soft over the next few months, global commodity prices stabilize 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," HSBC wrote in a report.

Joel Rebello contributed to this story.

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Published: 05 Aug 2015, 12:18 AM IST
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