While cutting the repo rate at which RBI lends money to banks by 25 basis points, the central bank said with low domestic capacity utilisation, still mixed indicators of recovery, and subdued investment and credit growth, there is a case for a cut in the policy rate
The Reserve Bank of India (RBI) on Tuesday cut repo rate (the rate at which the RBI lends money to banks) by 25 basis points to 7.25% from 7.50% with immediate effect. At the same time, the central bank has kept cash reserve ratio (CRR) unchanged at 4% in its second bi-monthly policy review today.
In a statement, Dr Raghuram Rajan, governor, RBI, said, "Banks have started passing through some of the past rate cuts into their lending rates. Headline inflation has evolved along the projected path. The impact of unseasonal rains has been moderate so far. Administered price increases remain muted and the timing of normalisation of US monetary policy seems to have been pushed back. With low domestic capacity utilization, still mixed indicators of recovery, and subdued investment and credit growth, there is a case for a cut in the policy rate today. "
"Yet, of the risks to inflation identified in April, three still cloud the picture. First, some forecasters, notably the IMD, predict a below-normal southwest monsoon. Astute food management is needed to mitigate possible inflationary effects. Second, crude prices have been firming amidst considerable volatility, and geo-political risks are ever present. Third, volatility in the external environment could impact inflation. Therefore, 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. With still weak investment and the need to reduce supply constraints over the medium term to stay on the proposed disinflationary path (to 4% in early 2018), however, a more appropriate stance is to front-load a rate cut today and then wait for data that clarify uncertainty. Meanwhile banks should pass through the sequence of rate cuts into lending rates," Dr Rajan said in a statement.
Reactign on the RBI policy decision, Arundhati Bhattacharya, chairman of State bank of India (SBI), the country's largest lender, said, "With credit demand expected to perk up, we anticipate the rate cut will transmit through the banking system sooner than later. With monsoon forecast going a little awry and the RBI upping its inflation projections for March FY16, the Government should now push for more public infrastructure spends that would support growth in the near term and create more jobs."
According to Chanda Kochhar, MD and CEO or ICICI Bank, the rate cut is a welcome step considering the need to further improve domestic demand and revive credit growth. She said, "The uncertainties cited in the policy statement present a pragmatic evaluation of economic conditions warranting a guarded approach, particularly with regard to risks to inflation and impact of monsoon. In summary, the policy stance is in alignment with the current economic conditions and the issues that require structural policy changes."
Commenting on the rate cut, V Vaidyanathan, Chairman, of Capital First, said, "The RBI has been consistent with approach by reducing rates by 25 bps. Their message to banks is the same as before, 'transmit the past rate cut'. Effectively the RBI has given guidance that the rate cut are done for now, and the markets should not expect more anytime soon. They will look for more decisive action from the government on supply bottlenecks. They will now wait for the monsoon event and drought and El Nino to pass by, before reacting again, as they are still concerned about monsoon.”
Liquidity conditions eased in April 2015 after the tightness in the second half of March 2015 on account of advance tax outflows and financial year-end behaviour of banks. During May, however, rapid increases in currency in circulation and a build-up of government balances resulted in liquidity conditions tightening again, the central bank said.
Agricultural activity was adversely affected by unseasonal rains and hailstorms in north India during March 2015, impinging on an estimated 94 lakh hectares of area sown under the rabi crop. According the central bank, to manage the impact of low production on inflation, there is need to have in place contingency plans for food management, including storage of adequate quantity of seeds and fertilisers for timely supply, crop insurance schemes, credit facilities, timely release of food stocks and the repair of disruptions in food supply chains, including through imports and de-hoarding.
"Industrial production has been recovering, albeit unevenly. The sustained weakness of consumption spending, especially in rural areas as indicated in the slowdown in sales of two-wheelers and tractors, continues to operate as a drag. Corporate sales have contracted. The disappointing earnings performance could have been worse if not for the decline in input costs. Capacity utilisation has been falling in several industries, indicative of the slack in the economy. While an upturn in capital goods production seems underway, clear evidence of a revival in investment demand will need to build on the tentative indications of unclogging of stalled investment projects, stabilising of private new investment intentions and improving sales of commercial vehicles," the RBI said.
In April, output from core industries constituting 38% of the index of industrial production declined across the board, barring coal production. The sustained revival of coal output augurs well for electricity generation and mining and quarrying, going forward. There is some optimism on gas pricing and availability. The resolution of power purchase processes has to be expedited and power distribution companies’ financial stress has to be addressed on a priority basis. Some public sector banks will need more capital to clean up their balance sheets and support lending as investment revives.
RBI said, leading indicators of services sector activity are emitting mixed signals. A pick-up in service tax collections, sales of trucks, railway freight, domestic air passenger and airfreight traffic could augur well for transport and communication and trade. On the other hand, the slowdown in tourist arrivals, railway traffic and international air passenger and freight traffic could affect hotels, restaurants and some constituents of transportation services adversely. The services PMI declined in April 2015, mainly because of slowdown in new business orders. Community and personal services are likely to be held back by the ongoing fiscal consolidation, it added.
In a report, Nomura said, the RBI is now data dependent watching monsoons, oil prices and external sector risks. "Although the RBI has left the door open to further easing in the event of further disinflation, we expect it stay on a prolonged pause (until end-2016), as we believe that growth is in the initial stages of a business cycle recovery, inflation appears to be stabilising around 5.0-5.5% and inflation expectations are still elevated," it added.
"While the rate cut is welcomed, the issue remains about transmitting the same by banks to the borrowers due to legacy issues of higher provisioning on asset quality. Under the circumstances, the RBI Governor's statement of announcing licenses for new Payments banks by August end is welcome to achieve the broad objective of financial inclusion and convenience to unbanked consumers," said Praveen Dhabhai, chief operating officer of Payworld, whose subsidiary 'Smart Payments Solutions' is an applicant for payment bank license.
Shishir Baijal, chairman & managing director of Knight Frank India, said, "Knight Frank India welcomes this move and we believe it's a step in the right direction. With a 25 bps cut in the repo rate, the key policy rate is now down by 75 bps this calendar year. However, we also think that an additional reduction in the CRR would have given a bigger boost to the struggling real estate sector by improving its cash crunch scenario. Moreover, it could have also increased the possibility of banks slashing their lending rates to benefit their borrowers."
The reverse repo rate under the liquidity adjustment facility (LAF) will be changed to 6.25%, and the marginal standing facility (MSF) rate and the bank rate at 8.50% with immediate effect.
Reverse Repo Rate.........6.50%