RBI surprises with 25 bps cut in interest rate

Raghuram Rajan-led RBI, which had been cautious in loosening its monetary policy stance, took a surprise decision cutting repo rate by 25 basis points to 7.75 per cent due to softening inflation. The rate cut came much ahead of its bi-monthly policy review scheduled for February 3.

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.

Consequently, the reverse repo rate 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 30-stock benchmark index rocketed over 1.7 per cent in early morning trades after the policy rate cut was announced.

Rajan noted that consumer inflationary pressure has been easing since July 2014. He said that 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.

He said that it has due to the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures for cereals and the large fall in international commodity prices, particularly crude oil. Rajan observed that crude prices, barring geo-political shocks, are expected to remain low over the year.

The RBI governor also noted that weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December and 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,” he said.

Rajan said that the 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,” Rajan said.

RBI has been under pressure for cutting interest rates for more than a year. While initially the pressure was anchored on falling growth rates more recently the calls for rate cut was based on decline in inflation rates.

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 first 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 for the last three months. 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.

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.

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

The wholesale inflation level also rose marginally to 0.11 per cent after sinking to 0 per cent in November.

(Edited by Joby Puthuparampil Johnson)

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