 "RBI signal: Budget first, rate cuts later")
It was his birthday on Tuesday, but Raghuram Rajan had no pleasant surprise to offer. A fortnight after cutting the key interest rate by 25 basis points, the Reserve Bank of India (RBI) governor left the repo rate unchanged at 7.75 per cent and decided to wait till the Union Budget, which will test the government’s resolve to stick to the medium-term fiscal deficit target.
RBI held out the prospect of more rate cuts, but said that would depend on the government’s efforts to reduce its fiscal deficit and fix the supply constraints that kept food and energy prices high.
“Given there was no development on the inflation or fiscal fronts since January 15, we have maintained status quo on interest rates... We have the Budget coming up. We will have new GDP (gross domestic product) numbers on February 9, which will reflect a whole new view of what is happening in the Indian economy,” Rajan told reporters after announcing the sixth bi-monthly policy review on Tuesday.
While the fiscal deficit target of 4.1 per cent of GDP for this financial year seems achievable, the central bank will keenly track whether Finance Minister Arun Jaitley sticks to the medium-term target of 3.6 per cent fiscal deficit for FY16 and three per cent the following year.
“With the Budget coming up in a few weeks, the next rate cut now seems likely to be off-cycle, perhaps in the first week of March,” Deutsche Bank said in a note to clients.
But the consensus in the market remains the central bank will opt for a 50-75-basis point rate cut this calendar year, including one before the next policy review, scheduled for April 7. “With a vindication that the ideal real rate of interest could be 1.5-2 per cent, the underlying message from the monetary policy is policy rates could go down by up to 75 basis points from the current level, assuming retail inflation is 5.5 per cent. The good thing, however, is rate cuts might be frontloaded so that the recovery is faster,” State Bank of India (SBI) said.
In its policy document, RBI cited a possible reversal of global crude prices, the monsoon and its impact on food inflation and the new base for the Consumer Price Index as some of the risks to further policy-easing.
Industry, which was hoping for a rate cut on Tuesday, was disappointed. The equity indices fell for a third consecutive session, as interest rate-sensitive stocks declined.
In its policy, the central bank reduced the statutory liquidity ratio (SLR) — the proportion of funds banks have to invest in government papers — by 50 basis points to 21.5 per cent. The move will release Rs 45,000 crore into the banking system.RBI held out the prospect of more rate cuts, but said that would depend on the government’s efforts to reduce its fiscal deficit and fix the supply constraints that kept food and energy prices high.
“Given there was no development on the inflation or fiscal fronts since January 15, we have maintained status quo on interest rates... We have the Budget coming up. We will have new GDP (gross domestic product) numbers on February 9, which will reflect a whole new view of what is happening in the Indian economy,” Rajan told reporters after announcing the sixth bi-monthly policy review on Tuesday.
While the fiscal deficit target of 4.1 per cent of GDP for this financial year seems achievable, the central bank will keenly track whether Finance Minister Arun Jaitley sticks to the medium-term target of 3.6 per cent fiscal deficit for FY16 and three per cent the following year.
“With the Budget coming up in a few weeks, the next rate cut now seems likely to be off-cycle, perhaps in the first week of March,” Deutsche Bank said in a note to clients.
But the consensus in the market remains the central bank will opt for a 50-75-basis point rate cut this calendar year, including one before the next policy review, scheduled for April 7. “With a vindication that the ideal real rate of interest could be 1.5-2 per cent, the underlying message from the monetary policy is policy rates could go down by up to 75 basis points from the current level, assuming retail inflation is 5.5 per cent. The good thing, however, is rate cuts might be frontloaded so that the recovery is faster,” State Bank of India (SBI) said.
In its policy document, RBI cited a possible reversal of global crude prices, the monsoon and its impact on food inflation and the new base for the Consumer Price Index as some of the risks to further policy-easing.
Industry, which was hoping for a rate cut on Tuesday, was disappointed. The equity indices fell for a third consecutive session, as interest rate-sensitive stocks declined.
However, as credit demand is low, banks are already holding SLR close to 28 per cent and, therefore, the move isn’t expected to have any immediate impact. The SLR reduction will only help banks when credit picks up. Yields on government bonds inched up following the reduction in SLR which comes into effect from February 7.
“The cut in SLR will serve the twin purposes of providing growth-supportive liquidity measures and preserving the interest spread,” said SBI Chairman Arundhati Bhat-tacharya. The move will release Rs 7,000 crore for SBI.
Barring two, no lender has reduced interest rates after the repo rate cut on January 15. Banks are unlikely to cut rates this financial year, with a rate cut likely only in April.
Bank of India Chairperson V R Iyer said for the bank, the cost of deposits had declined by only five basis points in the past three months. “These (costs) have to go down further before the bank decides to reduce lending rates. We have to wait for one-two months for rate cut,” Iyer added.
The central bank seemed to be aware of what was playing on banks’ minds, saying competition would force them to cut rates. “Many have been relatively quick to cut their deposit rates but not so quick to cut lending rates. I presume some are hoping they can get the spread for a little more time to repair their balance sheets. Eventually, competition is what matters,” Rajan said, indicating borrowers were raising funds through commercial papers that were charging a lower rate than bank credit. Credit growth in the banking system is sluggish, growing a mere 10.6 per cent year-on-year till January 9.
In a significant move, Rajan provided a much-needed boost to banks to deal with corporate distress, providing lenders more flexibility to restructure large projects that stalled when cash ran out.
Rajan said banks could extend timelines for large stalled projects by bringing in new ‘promoters’, or owners. “If a new promoter is brought in, banks could get some more time to complete the project. That could put some projects that are stuck back on the field,” he said.
He added the central bank was in talks to arrive at a deal with the Securities and Exchange Board of India to boost the equity banks could hold if they swapped bad debts for shares. Currently, banks cannot be left with a holding of more than 10 per cent after a debt-for-equity swap. That is set to increase to 30 per cent and talks are on to iron out pricing issues in this regard.
Read the full RBI Monetary Policy Statement
RBI MOVES
- Move: Repo unchanged; SLR cut 50 bps
- Impact: Banks won’t cut lending rates immediately, but will have more liquidity to support credit growth when it picks up
- Move: Norms for debt restructuring eased
- Impact: More acquisition of stressed assets
- Move: Foreign funds allowed to re-invest interest from government bond coupons
- Impact: It will free $2 bn for purchases of govt bonds a year; it also means overall investment limit of $30 bn for foreign investments will not be raised soon