Rajan signals pause after 25-bp rate cut

EMIs set to become cheaper with SBI, others trimming base rates

The Reserve Bank of India (RBI) on Tuesday took advantage of subdued inflation and cut the repo rate, the key policy rate, by 25 basis points (bps) to 7.25 per cent in line with market expectation. But the central bank signalled a prolonged pause on future rate cuts and termed monsoon as the "biggest uncertainty".

Data released earlier this month for April showed the Consumer Price Index (CPI)-based inflation eased to 4.86 per cent, the lowest in four months, on the back of another month of declining food prices. "With low domestic capacity utilisation, still mixed indicators of recovery, and subdued investment and credit growth, there was a case for a cut in the policy rate today [on Tuesday]," RBI Governor Raghuram Rajan said while announcing the second bi-monthly policy review of 2015-16, urging banks to pass on the rate cut.

Banks were quick to queue up, with State Bank of India (SBI), the country's largest lender, responding with a 15-bp base rate cut to 9.7 per cent. Allahabad Bank and Punjab & Sind Bank were the other two lenders that also announced base rate cuts till the time of going to press.

"More of liquidity will enable better transmission of rate cut. Interest rate cuts are not the only way to pump up growth. But, I must admit, that with repo rate down by 75 bps, banks will look at cutting rates," Arundhati Bhattacharya, chairman, SBI, said in her reaction to the rate cut to a private TV channel.

Commercial bankers were looking for a reduction in the cash reserve ratio (CRR) as they do not earn interest on it - a suggestion dismissed by the RBI governor. "It should be recognised that CRR is primarily a monetary instrument. If we want to reduce the cost of capital and lending rates, the more direct instrument to use is policy rate, which we have used," Rajan said.

Arvind Subramanian, chief economic advisor in the Union finance ministry, said the rate cut showed the economy was still in need of "policy support" as it recovered and welcomed the move.

The governor, however, said, "The biggest uncertainty for the Indian economy is weak monsoon. Others include rising oil prices and a slow recovery in the economy as reflected in the weak corporate earnings." Food prices are heavily dependent on the south-west monsoon, which contributes 90 per cent of the country's total rainfall. Poor monsoon could raise food prices and, hence, headline inflation.

The central bank also projected inflation would rise to six per cent in January 2016, setting up the possibility of no more rate cuts this year. Rajan said, "A conservative strategy would be to wait, especially for more certainty on both the monsoon outturn as well as the effects of government responses if it turns out to be weak." He added, "A more appropriate stance is to front-load a rate cut today [on Tuesday] and then wait for data that clarify uncertainty."

The reduction, he said, was not too big and not too small but just right, terming it a "Goldilocks policy".

If there was a weak monsoon, Rajan said, the government would have to manage the impact of low food production on inflation by with contingency plans in place for storage of seeds and fertilisers, crop-insurance programmes and credit facilities. He also warned that to contain inflation, the government should limit increases in prices paid to farmers for their produce. "We are under no illusion that the economy, especially investment, is up and running. It's not. It needs support," Rajan said. Investment has been weak and there is a need to "reduce supply constraints over the medium term to stay on the proposed disinflationary path", he added.

Chanda Kochhar, managing director and chief executive, ICICI Bank, said the uncertainties cited in the RBI policy statement presented a pragmatic evaluation of economic conditions, warranting a guarded approach, particularly with regard to risks to inflation and the impact of monsoon. In summary, she said, the policy stance was in alignment with the current economic conditions and the issues requiring structural policy changes.