RBI cuts rate, but banks won't budge

Repo rate down 25 bps to 7.25%; cash reserve ratio unchanged; central bank sees little room to ease policy furthe

The Reserve Bank of India (RBI) on Friday cut the key policy rate by 25 basis points for the third time since January and kept the cash reserve ratio (CRR) unchanged.

While that was on expected lines, what stumped market players was the central bank’s warning that there was little room to ease monetary policy further due to persistent risk of inflationary pressure. At 7.25 per cent, the repo rate is the lowest since May 2011.

In what is possibly his last annual policy statement, as he is scheduled to retire in September, RBI Governor D Subbarao, said: “The balance of risks stemming from our assessment of the growth-inflation dynamic yields little space for further monetary easing.”

He said the recent sharp decline in wholesale price index (WPI)-based inflation did not mitigate the possibility of rising prices and a high current account deficit, much above the sustainable limit of 2.5 per cent of gross domestic product, posed the biggest risk “by far” to the economy.

Though Subbarao was hopeful that banks would lower rates during the next three to six months, by amounts similar to RBI’s total rate cuts of 75 basis points in 2013, bankers ruled out any cuts, at least for now. State Bank of India Chairman Pratip Chaudhuri said “there is nothing to transmit”. Citi India CEO Pramit Jhaveri said: “The repo cut by itself will not necessarily result in transmission of rates or lead to higher growth prospects, unless accompanied by better liquidity conditions and more public sector, government and private investment spending.”

The bearish mood was visible in the markets as well, with stocks, the rupee, and bond prices falling, while other Asian markets were buoyant in the aftermath of yesterday’s rate cut by the European Central Bank.

India Inc didn’t hide its disappointment either. Confederation of Indian Industry President S Gopalakrishnan said he expected a “bolder intervention” from RBI in the form of a 50-basis point cut in repo rate and an equal amount of CRR cut. “Falling global commodity prices, expectations of a normal monsoon and a clear fiscal consolidation road map should have prompted RBI to revisit its monetary policy stance and lean more towards growth at a time like this, when fiscal room for providing stimulus is extremely limited.”

In his policy announcement, Subbarao sought to put the ball in the government’s court. “Recent monetary policy action by itself cannot revive growth. It needs to be supplemented by efforts towards easing the supply bottlenecks, improving governance and stepping up public investment, alongside continuing commitment to fiscal consolidation.”

The central bank said it expected the economy to grow 5.7 per cent in FY14 and projected WPI-based inflation at 5.5 per cent during the year. RBI said its intention was to lower WPI inflation to five per cent by March 2014 “using all instruments at its command”. Soon after the close of market hours, RBI announced open market operation (OMO) purchase of government securities up to Rs 10,000 crore. The OMO will be conducted on Tuesday.

Opinion was divided on RBI’s future course of action. HDFC Bank Chief Economist Abheek Barua said the policy was not only more hawkish than what macro conditions would warrant but also more guarded than the March review. Nomura’s Sonal Verma said despite the cautious guidance, she was hopeful of more space for rate cuts, given the recent fall in commodity prices and the expected containment of upside risks to inflation.

The government, too, was hopeful. Economic Affairs Secretary Arvind Mayaram said RBI would in the next policy “certainly see that there are adequate reasons for reconsidering  the interest rates and push for more growth”.

POLICY HIGHLIGHTS

* FY14 GDP growth pegged at 5.7%
* Inflation to remain range-bound around 5.5% in FY14
* March-end inflation seen at 5% against 6% a year ago
* Proposes doubling of priority sector lending limits to MSMEs to Rs 5 crore
* CAD seen as the biggest risk to the economy
* Credit growth pegged at 15%, against 14% in FY13
* Deposit growth estimated at 14%, against 14.3% in FY13
* Capital flight likely due to growth worries in advanced economies