RBI cuts rates to 6%, but cautiously

Reverse repo now 5.75%; maintains neutral monetary stance

The Reserve Bank of India (RBI) lowered its policy interest rate by 25 basis points (bps) and said the future course of inflation would depend upon a combination of factors, including states implementing farm debt waivers.

The six-member Monetary Policy Committee (MPC) observed the inflation rate had fallen to a historic low but “a conclusive segregation of transitory and structural factors driving the disinflation is still elusive”.

After the latest policy review, the repo rate, at which the central bank lends to banks, stands at 6 per cent. The RBI maintained its neutral monetary stance.

The rate cut was part of its calibrated approach based on the data available, RBI Governor Urjit Patel said in a post-policy conference. “We could have stronger growth by removing infrastructure bottlenecks, finding measures to reinvigorate private investments and providing a thrust to government’s affordable housing initiative, which has a potential for very strong multiplier effects,” Patel said.

“Addressing the twin balance sheet problem remains the RBI’s top priority,” RBI Deputy Governor Viral Acharya said, referring to the financial stress faced by banks and companies.

Five of the six MPC members voted in favour of a rate cut. 

Continuing with his previous stance, Ravindra Dholakia voted for a 50-bp cut. RBI Executive Director Michael Patra preferred a pause.

Acharya said the central bank was comfortable with a real interest rate of 1.75 per cent, the difference between the policy rate of 6 per cent and projected inflation of a little over 4 per cent. This, some in the markets perceived, as an indication that the room for a rate cut was limited or non-existent. The rupee strengthened to close at a two-year high of 63.70 a dollar, as high interest rates make India attractive to foreign investors. 

Even as State Bank of India (SBI) lowered its savings account deposit rate by 50 bps on Monday, the RBI governor said banks had held on to rates in segments other than the competitive housing and automobile loans. “There is scope for banks to reduce lending rates for those segments,” Patel said.

Bank bosses like Arundhati Bhattacharya of SBI and Chanda Kochhar of ICICI Bank remained non-committal on lending rate cuts.  Rana Kapoor, managing director and chief executive officer of YES Bank, said he saw “incremental rate cuts to the tune of 50-75 bps in coming months”.

Subhash Chandra Garg, secretary in the Department of Economic Affairs of the finance ministry, said the rate cut was an important step for sustained growth and moderate inflation.

“The RBI’s bias continues to be hawkish about medium-term inflation,” said Deutsche Bank’s Chief India Economist Kaushik Das, adding this could be the end of the RBI’s rate-cutting cycle. However, Indranil Sengupta, India economist for Bank of America Merrill Lynch, said there could be another 25-bp rate cut by December.

The RBI retained its inflation forecast at 2-3.5 per cent for the first half of the year and 3.5-4.5 per cent for the second half.

The trajectory of inflation would be determined by implementation of the Seventh Pay Commission’s recommendations on house rent allowance (HRA), price movements after the imposition of the goods and services tax, and the “disentangling of the structural and transitory factors shaping food inflation”, the RBI said.

“Implementation of farm loan waivers by states may result in possible fiscal slippages and undermine the quality of public spending, entailing inflationary spillovers,” the policy statement said.

“If states choose to implement salary and allowance increases similar to the Centre in the current financial year, headline inflation could rise by an additional estimated 100 bps above the baseline over 18-24 months,” the RBI said.

Excluding the HRA effect, headline inflation would be a little above 4 per cent by the fourth quarter, Patel said. A good monsoon and moderation in price increases would work as dampers, he added.

The RBI, however, noted households appeared to have discounted the recent low inflation and their inflation expectations had hardened.

The RBI kept its GDP growth projection unchanged at 7.3 per cent, but pointed out growth impulses in industry and services could be weakening. “The MPC was of the view that there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to affordable housing,” the policy statement said.

According to Patel, stakeholders should come together for speedier implementation and clearance of affordable housing at the state government level. 

The government and the RBI were also working to resolve bad debts and to recapitalise public sector banks, Patel said. These measures would help restart credit flows, he added.

Acharya said the investment slowdown was rooted in the bank balance sheet issues. 

Acharya said the RBI will take steps to improve financial intermediation like allowing tri-party repo transactions in corporate bonds, developing a public credit registry, and aligning the marginal cost of funds-based lending rate to market rates.

KEY TAKEAWAYS: Highlights of RBI’s third bi-monthly monetary policy

• Four of six members of MPC vote in favour of 0.25% rate cut
• Growth forecast unchanged at 7.3% for FY18
• Pushes for reinvigorating private investments, clearing infra bottlenecks and providing big thrust to housing for all 
• Centre, RBI working to resolve large NPAs and recapitalise PSBs
• High levels of stress in twin balance sheets – banks and corporations – likely to deter new investment