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Rajan opens door for rate cut early next year

Repo rate kept unchanged at 8% as RBI looks for 'certainty' on inflation; central bank says rate cut can be done even outside policy review cycle

BS Reporter  |  Mumbai 

Reserve Bank of India (RBI) Governor Raghuram Rajan on Tuesday held interest rates steady but held out hope for industry by saying the central bank could ease monetary policy early next year — even outside the policy review cycle — if the downward momentum in inflation continued and fiscal developments were encouraging. “(It is a) misconception among corporates that RBI is unconcerned about growth,” Rajan said at a press conference after the policy review. But keeping up with his inflation-warrior image, Rajan defended the status quo, saying he did not want to do a “flip-flop” on this front and was looking for “certainty” on various factors, primarily inflation, before lowering the key interest rate. “We have to make sure the disinflation process is well underway. We have had a couple of months (of low inflation) after five years of high inflation. We want to make sure this is for real, especially because we don’t intend to flip-flop,” he said. The repo rate was kept unchanged at eight per cent, a fifth straight bi-monthly monetary policy review at which the status quo was maintained. RBI also kept the key ratios — the cash reserve ratio and the statutory liquidity ratio —unchanged. The decision was broadly in line with expectations, as most economists and market analysts had expected the repo rate (the rate at which the central bank lends to banks) to remain unchanged, given the governor’s insistence on quelling inflation first.

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In a statement, the ministry said in the weeks ahead, the government and RBI would work towards a monetary policy framework that would help institutionalise the gains achieved on the inflation front. “The government looks forward to RBI supporting the revival of growth and employment,” the ministry said. Most analysts, however, said RBI’s idiom had changed from whether it would cut rates to when. The central bank’s next policy review is scheduled for early February and most expect it will either cut interest rates then or wait until April. State Bank of India Chairman Arundhati Bhattacharya said by advancing the inflation target of six per cent to March 2015, RBI had now sent out a clear message that the rate cycle would be reversed sooner rather than later. With oil prices at historic lows, a stable exchange rate and strong capital inflows, the feel-good factor is here to stay. HDFC Bank’s research team said a repo rate cut could be announced in April next year, as by then, the central bank would get more clarity on the pace of disinflation and the Union Budget could help RBI get a better handle on the government’s commitment to fiscal consolidation and its reform agenda. “Still, weak demand and the rapid pace of recent disinflation are factors supporting monetary accommodation. However, the weak transmission by banks of the recent fall in money market rates into lending rates suggests monetary policy shifts will primarily have signalling effects for a while,” RBI said. At the press conference, Rajan put it more bluntly: “It is not my job to tell banks what to do. Though rates have come down, they have not passed it on.” RBI has set a target of eight per cent retail inflation by January 2015 and six per cent a year from then. In October, retail inflation had hit a lifetime low of 5.52 per cent (the series was launched in February 2012), while Wholesale Price Index-based inflation slumped to a five-year low of 1.77 per cent, driven by softening prices of fuel and food items. With Consumer Price Index-based, or retail, inflation already within RBI’s target, Rajan had earlier hinted he would like to tackle the issue once and for all. Also, the overhang of a weaker-than-normal monsoon, which could put pressure on food prices, has not been entirely ruled out.

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In its statement, RBI mentioned the need to revive capital investment, and called on the government, which will announce its Budget for 2015-16 in February next year, to “stay on course” to meet fiscal deficit targets.

These targets have been jeopardised by weak tax revenue growth and the slow pace of selling stakes in state-run companies to raise funds. Tuesday’s decision, however, is likely to disappoint Minister Arun Jaitley, who has been batting for lower interest rates to further boost economic growth, as well as sections of Indian industry. Rajan also said corporate groups are often asked to pay higher interest rates because of their poor financials and inability to repay existing dues. “I also see there is a whole lot of confusion. The immense risk premium being demanded of some corporates is because of the state of their leverage, because of the risks they have taken, and because of their inability or unwillingness to repay. This should not be attributed to RBI. What we control is risk-free rate, what they can control is the risk premium demanded of them. This is something they should work on, even as we are working on bringing down inflation and the risk-free rate they have to pay,” Rajan said. The RBI kept its central estimate of growth at 5.5 per cent, while scaling down its inflation projection to six per cent by March-end next year. In the medium term, RBI expects inflation to stand at about six per cent, assuming a normal southwest monsoon, lower crude oil prices and no change in administered prices barring electricity. The RBI governor also said the central bank was in the process of finalising the monetary policy framework, adding the government seemed comfortable with adopting a target of about four per cent, with a band of +/-2 per cent beyond 2016. After having done away with gold import curbs through the week, Rajan didn’t sound too concerned about the high imports of gold, saying the fall in crude oil prices created some room in the current account. The move to do away with the 80:20 rule on gold imports was initiated from the government’s side and was a “reasonable” one, he said. Industry was disappointed. Ajay S Shriram, president of the Confederation of Indian Industry (CII), said at this juncture, even a symbolic cut in policy rates would have sent a strong signal. “CII feels the RBI will move in favour of growth at its next monetary policy and the new year will witness a cut in policy rates by at least 50 basis points,” he added. The stock markets also reacted negatively, with the Sensex falling 116 points. But government bond yields dropped and fell below the eight per cent mark, owing to dovish statements by the central bank. The yield on the 10-year bond ended at 7.97 per cent, compared with its previous close of 8.06 per cent.

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First Published: Wed, December 03 2014. 00:59 IST