RBI springs a surprise, cuts repo rate by 50 bps to 6.75%

The central bank responded to widespread calls to lower the interest rate to boost domestic investment

Ceding to impassioned calls by corporate India, not to mention Finance Minister Arun Jaitley, the Reserve Bank of India on Tuesday cut the repurchase, or repo, rate by a higher-than-expected 50 basis points to 6.75%, the lowest the key interest rate has been in four years. 
 
The cut means that the repo rate -- the rate at which the central bank lends to banks -- has been cut by 100 basis points this year; however, this is the first to be announced at a policy review – the first two cuts of 25 bps each in January and March were both outside of the policy review schedule.
                                                                            
The quantum of the cut is also higher than forecasts had suggested: a Reuters poll of 51 economists had shown that an overwhelming majority – 45, to be precise – had said it was likely that Governor Raghuram Rajan would lower the policy rate.

Indian industry is desperate for a pick-up in credit growth but has been hampered by a lack of monetary transmission of earlier cuts by banks, a point that Rajan has forcefully made to public sector banks. Bank, on their part, have turned cautious after a rising tide of stressed and non-performing assets, pushing back investment by domestic industry. On Tuesday, Rajan reiterated that transmission would be key, but cautioned that it may not happen at the pace one would like. 

Concerns over inflation, though, remain. Rajan has made lowering inflation to sustenable levels a cornerstone of his governorship so far, and has largely succeeded in bringing down inflation levels to below the RBI’s own targets. Retail inflation fell to a record low of 3.66% in August, and could well stay under Rajan’s self-imposed target of 6% by January 2016. However, the decline in prices has largely been driven by global factors such as a steep fall in oil and commodity prices.
 
But with a poor monsoon just over, the coming months could see prices jump again as the effects of a poor harvest kick in, wiping out the gains of a positive base effect of the past couple of months.

Earlier in the August policy, RBI had hinted that there could be further reduction in key rates depending on inflationary pressures, monsoon and the liklely Federal Reserve actions and full transmission of its frontloaded past actions. 

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.

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. It said that since then, inflation has dropped to a nine-month low, as projected.

RBI said that looking forward, inflation is likely to go up from September for a few months as favourable base effects reverse. It said that the outlook for food inflation could improve if the increase in sown area translates into higher production. ".. inflation is expected to reach 5.8 per cent in January 2016, a shade lower than the August projection," RBI said. 

"Since our last review, the bulk of our conditions for further accommodation have been met. The January 2016 target of 6 per cent inflation is likely to be achieved," it further said. 

GLOBAL HEADWINDS

 
The US Federal Reserve has hinted that a hiking of interest rates there is no longer an ‘if’ but a ‘when’. At a recent university address, US Fed chairperson Janet Yellen – who had to receive medical attention right after struggling to finish her talk – said the US central bank was on track to raise interest rates this year for the first time in nearly a decade. If that happens, it could see a sudden exit of foreign money from Indian markets, leading to turmoil on both equity and currency markets.
                                                                                                                        
Adding to global growth worries is the slowdown in China, which has in recent years emerged as a barometer of global demand, thanks to its stature as a manufacturing behemoth. Internally, too, China’s domestic demand, no quisling itself, has also dipped. China’s growth has slipped – industrial profit in August dropped 8.8% to its lowest level since 2011, while September PMI fell to a six-and-a-half-year low of 47. Earlier this month, China cut its GDP forecast for the third quarter from 7.4% to 7.3%, a decline of 10 basis points, sending global markets into a downward spiral. As it is, a series of breath-taking slumps in Chinese markets have spooked world markets and raised concerns about the stability and oversight of China’s exchanges.