Ignoring the clamour for an easing of monetary policy, India's central bank on Tuesday kept its key lending rates unchanged, sticking to its stand that further cuts can only be effected if commercial lenders pass on the previous reductions to borrowers.
After having cut the short-term lending rate thrice thus far in this calendar year to bring it down to 7.25 percent, Reserve Bank of India (RBI) Governor Raghuram Rajan said a host of factors led to a status quo on Tuesday's monetary policy update.
"Since the first rate cut in January, the median base lending rates of banks has fallen by around 30 basis points, a fraction of the 75 basis points in rate cut so far," Rajan said in the central bank's monetary policy update at the Mint Street headquarters here.
"As loan demand picks up in Q3 of 2015-16, banks will see more gains from cutting rates to secure new lending, and more transmission will take place," he said, adding that liquidity will not be a cause for worry since the government has decided to infuse more capital into state-run banks.
He, however, pointed to some areas of concern, while also some cheering factors.
"Turning to the balance of inflation risk, most worrisome is the sustained hardening of inflation excluding food and fuel. Moreover, the full effects of the service tax increases that took effect from June, will feed through over the rest of the year," he said.
"The outlook for growth is improving gradually. Favourable real income effects could accrue from weaker commodity prices, in particular crude oil, and a possible step-up in agricultural activity if monsoon conditions continue to improve," he added.
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"Taking into account all this and given that policy action was front-loaded in June, it is prudent to keep the policy rate unchanged at the current juncture, while maintaining the accommodative stance of monetary policy."
As a result of the policy update on Tuesday, the repurchase rate, or the short-term lending rate of the central bank, remains unchanged at 7.25 percent and so does the cash reserve ratio (CRR), or the liquid money banks have to compulsorily hold, at 4.00 percent.
Accordingly, the reverse repo rate, or the central bank's short-term borrowing rate, remains at 6.25 percent.
The markets was choppy as a result of RBI maintaining status quo on lending rates. The barometer-- sensitive index (Sensex) of the Bombay Stock Exchange (BSE) ended the day's trade down 115 points.
It had receded by over 220 points just after the RBI announced a status quo. However, the index soon recovered mainly on account of Rajan's announcement at a post-update press conference that the bank will soon change the cap on bond investment from being dollar-linked to rupee-denominated.
It is expected that the move will give an additional space of nearly $5-6 billion of investments in the debt markets, whose limit of $30 billion has almost been exhausted.
The RBI governor also elaborated plans to segregate the bond market participation limits. The move is expected to attract more long-term fund, while at the same time keep the "hot money" or short-term investments at bay.
The central bank said that it is engaged with the government over the new financial code which is expected to clip RBI's autonomy.
During the assessment, Rajan also did not think much of investment-led growth, while maintaining the country's gross domestic product (GDP) growth at 7.6 percent for the current fiscal, and an inflation target of around 6 percent in January next year.
"Notwithstanding some improvement in the state of stalled projects, supply constraints continue to be binding and new investment demand from the private sector and central government remains subdued," the central bank governor said.
As far as price rise and average citizens are concerned, he said: "Some food prices, particularly of protein-rich items, pulses and oilseeds have risen sharply in recent months. They will have to be carefully monitored as they tend to be sticky and impart an upward bias to inflation."
The country's largest lender State Bank of India (SBI) said RBI's forward guidance spells out possibility of more monetary accommodation.
"With monsoon projections better than anticipated and declining commodity prices there are indeed rooms for more monetary accommodation," said Arundhati Bhattacharya, chairman of SBI.
Whereas, the largest private sector bank said that RBI has opted to monitor inflation trends for some more time.
"Inflation is within the targeted range and should this trend sustain, we could see further policy rate action as well," said Chanda Kochhar, managing director and chief executive, ICICI Bank.
Industry body, Confederation of Indian Industry (CII) hoped that RBI would resume monetary easing in its next policy meet, by when it expects more clarity on inflation trajectory, monsoon and the possible US Fed rate hike.
Another major businesses association Federation of Indian Chambers of Commerce and Industry (Ficci) predicted that the latest capital support provided to the public sector banks should enable effective transmission into lower lending rates.