RBI surprises with more-than-expected rate cut

Nithin Belle/Mumbai
Filed on September 30, 2015 | Last updated on September 30, 2015 at 08.28 am
Reserve Bank of India
Reserve Bank of India


Despite consumer inflation having plunged from almost double-digit figures when he took over in September 2013 to 3.66 per cent in August, Rajan chose not to go for sharp rate cuts.

In a surprise move, Reserve Bank of India Governor Raghuram Rajan on Tuesday cut the key repo rate by 50 basis points to 6.75 per cent, the lowest in nearly five years, yielding to pressures from government and industry, clamouring for such a sharp rate cut.

Unveiling the fourth bi-monthly monetary policy statement for fiscal year 2014-15, Rajan said since the previous review the bulk of the conditions for easing the policy had been met. Inflation has dropped to a nine-month low and despite the monsoon deficiency and its uneven spatial and temporal distribution, food inflation pressures have been contained by resolute actions by the government, he added.

While reducing the policy repo rate - the rate at which the central bank lends money to commercial banks - under the liquidity adjustment facility, he kept the cash reserve ratio unchanged at four per cent. The reverse repo rate has been adjusted to 5.75 per cent.

The Indian finance ministry and industry bodies have over the past few months been urging the RBI to ease the monetary policy, especially since inflation was under control. Many industrialists had also blamed the governor for the slowdown in the economy, citing the high interest rates and lack of liquidity.

Ever since he took over as governor of the central bank about two years ago, the former finance professor at the University of Chicago and the former chief economist of the International Monetary Fund has been adopting a tough stance on interest rates. Despite consumer inflation having plunged from almost double-digit figures when he took over in September 2013 to 3.66 per cent in August, Rajan chose not to go for sharp rate cuts. 

RBI surprises with more-than-expected rate cut (KT3405929.JPG)

Since January, he has cut the repo by 125 basis points, opting for 0.25 per cent cuts on three previous occasions up to June. Most analysts and business lobbies were expecting a similar 0.25 per cent cut this time as well. Rajan, however, said that he had not been "excessively aggressive" this time while cutting rates.

The governor cited several reasons to justify the rate cut, including the tentative economic recovery in the country, uneven growth by the manufacturing sector, weakening construction activity and declining merchandise exports.

"Since our last review, the bulk of our conditions for further accommodation have been met," said Rajan. "The January 2016 target of six per cent inflation is likely to be achieved. In the monetary policy statement of April 2015, the RBI said that it would strive to reach the mid-point of the inflation band by the end of fiscal year 2017-18. Therefore, the focus should now shift to bringing inflation to around five per cent by the end of fiscal year 2016-17."

The stock markets welcomed the RBI's move. The Sensex on the Bombay Stock Exchange, which had plunged in the morning hours, leapt back gaining 500 points from the day's low. It ended the day at 25,778.66, a gain of 161.82 points (0.63 per cent). The Nifty on the National Stock Exchange rose by 0.61 per cent. The Indian rupee also gained 0.5 per cent against the US dollar, while bonds rallied, with the yield on 10-year government paper hitting a two-year low of 7.56 per cent..

Industry bodies welcomed Rajan's move, claiming it would trigger off growth. "We are happy that the RBI has finally recognised the weakness in underlying economic activity and the need for a reduction in borrowing rates to drive recovery," said Chandrajit Banerjee, director-general of the Confederation of Indian Industry.

D.S. Rawat, secretary-general of the Associated Chambers of Commerce of India, described the move as "a pleasant surprise" and dubbed it as a Diwali bonus. "What is even more heartening is the kind of resolve by Rajan to work with the government and ensure that the banks pass through the rate cut without delay."

Lakshmi Iyer, chief investment officer and head products at Kotak Mutual Fund, said the alacrity and swiftness of the policy response by the RBI positively surprised the market. "Inflation pressure is declining and the long-term inflation trajectory is on the downward slope as supply bottlenecks continue to open up," she said. "This creates an enabling environment for a more accommodative policy stance in future." 

With the global economy increasingly seeing India as a lucrative growth spot, it will be incumbent on the government and the central bank to work in tandem to further boost opportunities, added Iyer.

Welcoming the move, Anshuman Magazine, chairman and managing director of CBRE South Asia, said it would provide the necessary support to the economy as well as the real estate sector.

"The RBI's proposal to reduce the minimum risk weightage on individual housing loans for low cost homes will also help revive sales apart from  lending support to the government's 'Housing for All' scheme."

Anuj Puri, chairman and country head of JLL India, said the RBI has "clearly abandoned its cautious baby-steps approach and assumed a bolder stance, obviously because the current economic fundamentals provide it with the room to do so".


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