RBI Surprises with 50 bps Repo Rate Cut
In a much-needed booster shot to the economy, RBI governor Raghuram Rajan on Tuesday cut the repo rate by 50 basis points, front loading policy action in view of contained inflationary pressures and weak economic activity. The Reserve Bank of India (RBI) on Tuesday cut its repo rate by 50 basis points to 6.75%, while keeping the cash reserve ratio (CRR) unchanged at 4%. While the Reserve Bank's stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed. The Reserve Bank will continue to be vigilant for signs that monetary policy adjustments are needed to keep the economy on the target disinflationary path
Five reasons why Rajan decided to surprise with a 50 bps Rate Cut:
1) Inflationary pressures contained: Despite the monsoon deficiency and its uneven spatial and temporal distribution, food inflation pressures have been contained by resolute actions by the government to manage supply. The disinflation has been broad-based and inflation excluding food and fuel has also come off its recent peak in June. In the bi-monthly policy statement of August, the Reserve Bank indicated that further monetary policy accommodation will be conditioned by the abating of recent inflationary pressures, the full monsoon outturn, possible Federal Reserve actions and greater transmission of its front-loaded past actions. Since then, inflation has dropped to a nine-month low, as projected.
2)Inflation projection: It is important that pro-active supply-side management by the government be in place to head off any food price pressures should they materialize, especially in respect of onion and pulses.
3) Economic activity weak: The modest pick-up in the growth momentum in the first half of 2015-16 benefited from soft commodity prices, disinflation, comfortable liquidity conditions, some de-clogging of stalled projects, and higher capital expenditure by the central government.
4) Accommodative policy needed: Still-low industrial capacity utilisation indicates more domestic demand is needed to substitute for weakening global demand in order that the domestic investment cycle picks up.
5) Transmission issues: While markets have transmitted the Reserve Bank's past policy actions via commercial paper and corporate bonds, banks have done so only to a limited extent. "The median base lending rates of banks have fallen by only about 30 basis points despite extremely easy liquidity conditions.
The central bank also said that ith global growth and trade slower than initial expectations, a continuing lack of appetite for new investment in the private sector, the constraint imposed by stressed assets on bank lending and waning business confidence, output growth projected for 2015-16 is marked down slightly to 7.4 per cent from 7.6 per cent earlier. The Reserve Bank Governor has been under pressure from the Finance Ministry as well as the industry to cut interest rate to spur economic recovery and mitigate the impact of slowing China on India.