Your turn now, RBI tells government

Central bank cuts key repo rate by 25 bps to 7.5%, but signals that the rate-easing cycle may be nearing an end

 

A file photo of the RBI building in Mumbai. Photo: Abhijit Bhatlekar/Mint 

Mumbai: The Reserve Bank of India (RBI) on Tuesday trimmed its key lending rate by a quarter percentage point, doing so for the third time in the past one year, to breathe life into Asia’s third largest economy, but signalled that its rate-easing cycle may be nearing an end despite concerns of slowing growth.

The widely anticipated cut is unlikely to result in a lower cost of funds for retail or corporate borrowers, and, in its guidance, the central bank expressed its concern over inflation and the size of India’s current account deficit (CAD).
“Headline inflation is expected to be range-bound around current levels over 2013-14... Risks on account of the CAD remain significant. Accordingly, even as the policy stance emphasizes addressing the growth risks, the headroom for further monetary easing remains quite limited,” RBI said.
And, while admitting the role of a low interest rate regime in boosting economic growth, it emphasized that it was more important for the government to address issues related to capacity building, fiscal prudence and governance itself.
The apex bank kept the cash reserve ratio (CRR), the portion of deposits banks need to park with RBI, unchanged at 4%.
For the financial market, RBI’s rate action was largely a non-event as it had factored in the move, but the apex bank’s caution on future rate cuts weighed heavily, driving the bellwether equity index, the S&P BSE Sensex, by 353 points below the psychologically important 19,000 mark.
The rupee fell by half a percentage point and bond yields rose.
The Sensex later pared some of its losses to close the day at 19,008.10 points, down 1.48%, while the rupee ended at 54.38, down 0.37%. The yield on India’s 10-year bond ended at 7.91%, up from 7.87% at the last close.
More than the RBI action, the decision by the Dravida Munnetra Kazhagam to withdraw support from the Congress-led United Progressive Alliance government dampened market sentiment, analysts said.

The 25 basis points (bps) cut in the repo rate, at which RBI lends short-term funds to banks, to 7.5% will not benefit borrowers in the near future as leading banks have ruled out any immediate cuts in lending rates. A basis point is one-hundredth of a percentage point.
“A repo rate cut doesn’t mean much for the banking system, as it will not bring down our cost. Any significant cut in lending rates is unlikely,” said Pratip Chaudhuri, chairman of State Bank of India, the country’s largest lender. A cut in CRR would have enabled the bank to lower its lending rates further, he added.
R.K. Bansal, executive director of IDBI Bank Ltd, also ruled out any immediate reduction in rates. “The deposit rates have to first come down before reduction in lending rates, but high inflation poses hurdles to lower the deposit rates,” Bansal said
For companies, there was not much reason to cheer. “CII (Confederation of Indian Industry) was hoping that the RBI would go ahead with a 50 bps reduction in the repo rate to make a significant impact on investor sentiments,” said Adi Godrej, president of the lobby group.
Naina Lal Kidwai, president of the Federation of Indian Chambers of Commerce and Industry, another industry lobby, said the association hopes that “RBI will follow this up with further rate cuts even though they have indicated that headroom for further cuts is limited”
RBI began cutting rates in April last year after hiking it 13 times between March 2010 and October 2011 to fight inflation. Since then, it has cut the repo rate by 100 bps and slashed CRR by 75 bps.
Meanwhile, the Indian economy is estimated to expand at a decade’s low of 5% in the year ending 31 March by the government’s own estimates.
Unlike the 2008 financial crisis, following which RBI sharply eased its monetary policy to boost growth, the central bank has been cautious this time due to surging inflation and the rising fiscal deficit.
Inflation based on wholesale prices has fallen below 7% in recent months after staying above that level throughout the past year. After easing to 6.62% in January, it inched up to 6.84% in February. But core inflation, or non-food, non-oil manufacturing inflation, eased significantly to 3.79% in February from 4.12% in January.
But RBI is not confident of inflation easing in the new fiscal year. “Notwithstanding moderation in non-food manufactured products inflation, headline inflation is expected to be range-bound around current levels over 2013-14 in view of sectoral demand-supply imbalances, the ongoing corrections in administered prices, and their second-round effects,” it said.
While acknowledging the need to support growth, the Indian central bank reiterated its stance that efforts to boost growth should come primarily from the government. “A competitive interest rate is necessary for this, but not sufficient. Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance,” RBI said.
Planning Commission deputy chairman Montek Singh Ahluwalia said the rate cut was a “clear signal” that inflation is subsiding. Noting that RBI’s move will lead to “softening” of rates, Ahluwalia said the rate cut “could have been larger”.
C. Rangarajan, chairman of the Prime Minister’s economic advisory council, said any further rate action will depend on how inflation behaves. According to the former RBI governor, policy action will be “very difficult” going ahead unless inflation declines
Also, RBI may step up open-market operations (OMOs), or bond purchases from the market, to manage liquidity in the banking system, Rangarajan said.
RBI has been extensively conducting OMOs to ease liquidity. Tight liquidity has forced banks to borrow an average Rs.1 trillion daily from RBI’s liquidity window since January. On Tuesday evening, the central bank announced a Rs.10,000 crore OMO to be conducted on 22 March.

 TOUHID HUSSAIN
PGDM 2nd SEM
IIMT COLLEGE OF MANAGEMENT