facebook-page-view
Advertisement

RBI cuts rate again by 25 bps to 7.5%

By TEAM VCC

  • 04 Mar 2015
RBI cuts rate again by 25 bps to 7.5%
Reuters | Credit: Raghuram Rajan

Raghuram Rajan-led RBI, which had been cautious in loosening its monetary policy stance, surprised the markets again with another cut in key monetary policy rate, the second time in last two months, by 25 basis points (bps) to 7.5 per cent, on Wednesday.

Advertisement

The stock markets reacted positively with the 30-stock benchmark Sensex rising over 1 per cent in early morning to hit the psychologically sensitive 30,000 mark in intra-day trades.

Rajan's decision comes right after a government presented its Union Budget and the consensus on new monetary policy framework with flexible inflation targeting.

Advertisement

This is the second mid-term rate cut by the RBI after it snipped the repo rate by a similar percentage to 7.75 per cent due to softening inflation in January.

Advertisement

The latest rate cut came much ahead of its first monetary policy review of the coming fiscal scheduled for April 7.

It, however, kept the cash reserve ratio (CRR) of scheduled banks unchanged at 4 per cent and said it would continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise net demand and time liabilities at the repo rate and liquidity under 7-day and 14-day term repos of up to 0.75 per cent through auctions besides daily variable rate repos and reverse repos to smooth liquidity.

Advertisement

Consequently, the reverse repo rate 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.

Advertisement

Rajan noted that the need to act outside the policy review cycle is prompted by two factors: 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; secondly, 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.

He said, 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.

“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,” he said.

Rajan, who took over as the RBI chief in September 2013 had initially took a hawkish stance raising repo rate in his first month on the job from 7.25 per cent to 7.5 per cent. Thereafter he raised it further to 7.75 per cent in the following month and further to 8 per cent in January 2014.

This happens to be the second rate cut since then.

The consumer inflation, which is now the guiding light for monetary policy decisions, has been under the RBI's long run comfort level of 6 per cent since the last quarter of 2014. It rose marginally to 5 per cent in December after sinking to 4.38 per cent in the previous month, the lowest level since January 2012, since when the government started compiling new consolidated national statistics for consumer inflation in India. In January it rose marginally to 5.11 per cent.

RBI has been looking for a sustained decline in consumer inflation with a target of bringing inflation down to 8 per cent by January 2015 and 6 per cent by January 2016. However, the new monetary policy of 2-6 per cent (4 per cent +/- 2 per cent) consumer inflation now supersedes this.

October happened to be the first month when consumer inflation went under the RBI's long-term target.

Wholesale prices indicates India has slipped into deflation with wholesale price index (WPI) declining 0.39 per cent in January over the year-ago period after remaining close to zero for the previous two months, official figures showed.

RBI governor said that 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,” he added.

Reflections on growth, Budget

Referring to the change in base year which has bumped up the GDP growth statistics of the economy, RBI governor said that the picture it presents of a robust economy 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,” according to Rajan.

He also talked about the Budget presented last weekend and noted that 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,” Rajan said.

He observed that some factors mitigate the concern.

Rajan said that with the government transferring a significantly larger amount of tax receipts to the states, without entirely devolving responsibility for funding central programmes, state budget deficits will narrow and so will the general fiscal deficit. Moreover, it commended the move to cut fuel subsidies to invest more in infrastructure and to utilise direct transfers as a mode to subsidise. It also applauded the government and RBI now being in-sync on monetary policy, as against being at odds with each other in the past.

He cautioned, however, that all these mitigating factors have a fair component of intent and the realised net fiscal impulse will depend on both central and state government actions going forward.

Rajan also reiterated that RBI does not target a level for the exchange rate, nor does it have an overall target for foreign exchange reserves.

Share article on

Advertisement
Advertisement