RBI Cheers With Rate Cut

The new deity at Mint Road has answered the prayers of India Inc. The 24th Governor of the Reserve Bank of India (RBI) Urjit Patel, in his maiden monetary policy review cut the repo rate by 25 basis points (bps) to 6.25 per cent with immediate effect.

Better still, the decision to cut the repos rate was unanimous with all six members of the Monetary Policy Committee (MPC) voting in favour. The MPC was of the view the recent drop in inflation reflects a downward shift in food inflation momentum; that it opens up space for policy action. It was also pointed out the implementation of the 7th Pay Commission recommendations (especially the increase in house rent allowance, and the increase in minimum wages due to possible spillovers through minimum support prices), could pose a challenge going ahead. The central bank retained its March 2017 inflation target of 5 per cent with upside risks that have reduced compared with August's five per cent driven by a sharp drop in food inflation due to good monsoons at just three per cent below the long-period average.

V S Parthasarathy, CFO-Mahindra Group said the 25 bps repo rate cut served as a signal from the RBI to anchor future expectations. "This policy was a window into the thoughts of the Governor and the MPC. It is not only about the here and now, it is also about what the MPC thinks about risks and importantly it reveals the Governor's thoughts on structural matters. The focus will be on NPAs, financial market reforms, and financial inclusion for MSME".

Rana Kapoor, MD & CEO, YES Bank was of the view that Patel's maiden policy decision (and the MPC) is completely justified by the ongoing disinflation in the economy. "Today's rate cut will boost sentiment and contribute towards reinvigorating growth impulses in the infrastructure, construction and manufacturing sectors. Backed by a healthy set of domestic macros and sustained global deflation, I expect 75 bps further easing in the coming months", he said.

Bankers are now in huddle and Base Rate cuts are expected later in the evening. Expect the upcoming festive season to a cheerful one for borrowers.

It was in the offing

BW had pointed on 9th August 2016 (governor Raghuram Rajan's last policy) that a rate cut may well be around the festive season. The cues were evident -- on the face of it inflationary concerns seemed to have held back Mint Road from slashing policy rates, but on a closer reading, it was evident there will be reason to cheer around the festive season.

Rajan had as expected kept the repo rate unchanged at 6.5 per cent; so too the cash reserve ratio at four per cent. That's because retail inflation (Consumer Price Index; CPI) had nosed up to a 22-month high level of 5.77 per cent in June 2016 (it was at 5.40 per cent in June 2015) on the back of an increase in prices of vegetables and cereals. CPI was marginally lower at 5.76 per cent in April. Now given the four per cent inflation target (for the next five years), the headroom for an accommodative monetary policy had largely dried up.

But if one had read between the lines, there were cues to indicate a rate cut was on the cards. State Bank of India chairperson Arundhati Bhattacharya had then noted the RBI decision to maintain status-quo was as per market expectations. The decision to frontload liquidity provisions through an announcement of OMO is a well thought out move as capital flows have been relatively slow this year given the global uncertainties, resulting in lower net foreign exchange acquisition. She had added "transmission of rates will happen gradually over the next few months as credit growth picked up pace".

It was a view seconded by Kapoor of Yes Bank when he said: "In the coming months, the disinflationary impact will be upheld by a favourable monsoon and structural policy reforms instituted by the government. Hence, notwithstanding the current pause, this will engender 50-100 bps space for incremental monetary easing before end of fiscal'17".

In August, the focus seemed to be on making sure liquidity conditions remained adequate despite there being no rate cuts as evidenced from RBI's frontloading of OMO - the purchase of securities to inject liquidity in the system. It made sense as given the lacklustre demand for credit, no point would have been served by cutting policy rates at that stage; and more visibility was needed on inflation anyway. Second, rate cuts in the past had not led to lending rate cut by banks. So it had made sense to wait.

Rajan too had touched upon the structural issues regarding the transmission effect of lending rates - they had held firm despite cuts in policy rates over the year. He alluded to the fact that bankers seem to come up with fresh excuses for not passing on policy rate cuts to customers: "Earlier, some bankers said that it was the lack of liquidity that was holding rates high, now I hear from some that it is fear of the FCNR (B) redemptions that is making them reluctant to cut rates. I have a suspicion that some new concern will crop up once these redemptions are behind us".

In effect, Rajan seemed to concede lending rates should be lower than what they are now - just that banks have not passed on past policy rate cuts. As for a fresh policy rate cut, Rajan left it to the new person on the 18th floor at Mint Road to take a call. He's done that!