In his last policy, Rajan puts onus on banks

RBI keeps rates unchanged; ensures adequate liquidity in the system

In his last monetary policy as Reserve Bank of India (RBI) governor, Raghuram Rajan kept the policy rates unchanged. He, however, ensured that banks would not run out of liquidity, making sure that lenders don’t have this excuse for not passing on the cumulative 150 basis point rate cuts announced since January 2015.

The policy stance remained accommodative and focused on ensuring adequate liquidity in the system.

This was probably also the last policy where the governor got to take the final call on the policy rate. If things move as expected, the policy decision on October 4 would most probably be taken by a six-member Monetary Policy Committee (MPC), in which the RBI governor would be a member, albeit with a casting vote in case of a draw.

 
In a post-policy conference with the media, Rajan said the three members in MPC from the central bank side would be the RBI governor, deputy governor in charge of monetary policy Urjit Patel and executive director Michael Patra.

Rajan said his three years at the helm of RBI, which comes to an end on September 4, were a “fantastic experience,” and hoped his colleagues and he managed to “move the needle forward a little bit.”

Rajan said he would put the remaining 28 days of his tenure to good use by announcing a slew of policy measures, including one that tightens the screw on banks that refuse to lower lending rates. The RBI will unveil measures on August 25 to improve the functioning of the markets, especially the corporate bond markets – the development of which is probably part of Rajan’s unfinished agenda.

The RBI’s rate decision on Tuesday was explained by the sudden rise in prices in the past two months, but the central bank was confident that it would contain the Consumer Price Index (CPI)-based inflation within 5 per cent by March 2017.

After the third bi-monthly monetary policy review of the financial year, the repo rate remained at 6.5 per cent.     

All other rates, including the mandatory bond holding limit for banks and the cash reserve requirement remained unchanged too. In keeping with the trend of pumping adequate liquidity into the banking system, the RBI announced an open market operation (OMO) to purchase bonds worth Rs 10,000 crore. Despite the system having surplus liquidity, this is not structural but seasonal. Actions like OMO inject more durable liquidity in the system.  

“Broadly speaking, we were at a deficit of about 1 per cent of NDTL (net demand and time liabilities) and we are moving to eliminate that over time. The answer is, we are probably about 40 per cent of the way at this point,” Rajan said in his interaction with the media.

Liquidity will not be unduly impacted by redemptions related to the foreign currency non-resident (FCNR) deposits, estimated at about $26 billion (about Rs 173.9 crore). The RBI had earlier estimated that the system would see a dollar shortage of about $20 billion because the redemption as a part of the FCNR deposits were bought taking loans from the same banks. The RBI on Tuesday said it was prepared to face any volatility.

“We will be monitoring the markets. We do not want to give any blanket guarantee that there will be no volatility. We want banks to be prepared to deliver to us. But if there is volatility, we will do what is necessary,” Rajan said.

The decision to keep rates unchanged was expected, considering the recent fixing of the inflation target at 4 per cent, plus or minus 2 per cent, in the next five years. However, the scope for future rate cuts has reduced considerably as a result.

But Rajan said ruling out future rate cuts wouldn’t be correct.

“I don’t think it is possible to say that there is this future inflation anticipated and therefore it will be impossible to cut rates. Your rate cut is done taking into account the time path of inflation. So, if you expect more inflation in the future then you won’t cut rates now,” Rajan said.

CPI-based inflation showed a two-year high of 5.80 per cent both in June and May, higher than the RBI’s comfort zone. Analysts say the numbers would continue to be high till September because of the base effect. Food inflation is mostly responsible for the increase.

RBI, in its policy, said the good monsoon and improved supply management augured well for food inflation, but it flagged concerns about inflation outside food.  

“The prospects for inflation excluding food and fuel are more uncertain; if the current softness in crude prices proves to be transient and as the output gap continues to close, inflation excluding food and fuel may likely trend upwards and counterbalance the benefit of the expected easing of food inflation,” the monetary policy document said.

In addition, the implementation of the Seventh Central Pay Commission (CPC)’s award on allowances will increase house rent inflation.

Nevertheless, the RBI said it would be able to meet the March 2017 inflation target, albeit with risks “tilted to the upside.”

Meanwhile, growth momentum would quicken because of the monsoon raising agricultural growth and rural demand, “as well as by the stimulus to consumption spending that can be expected from the disbursement of pay, pension and arrears following the implementation of the CPC’s award.”

The passage of the goods and services tax (GST) Constitution amendment Bill augurs well, the policy said. “While timely implementation of GST will be challenging, there is no doubt that it should raise returns to investment across much of the economy, even while strengthening government finances over the medium-term. This should boost business sentiment and eventually investment.”

Growth will also get a boost because of the continued accommodative stance of monetary policy and comfortable liquidity conditions, but the prospect of global growth remains stunted for now, the policy said.

The RBI maintained its growth projection for 2016-17 at 7.6 per cent, with risks evenly balanced.

Rajan, in his opening remarks took a dig at banks for not passing on past rate cuts.

“Earlier, some bankers said it was the lack of liquidity that was holding rates high, now I hear from some that it is fear of FCNR(B) redemptions… I have a suspicion that some new concern will crop up once FCNR(B) redemptions are behind us,” Rajan said, adding the central bank would tweak its norms on marginal cost-based lending rate (MCLR) to make banks budge. However, he acknowledged that banks may not be at fault completely.

“However, substantial pass through will happen only as corporate credit demand picks up, and public sector banks, strengthened by clean balance sheets, compete for corporate business,” Rajan said.

Arundhati Bhattacharya, chairman of State Bank of India, said transmission will indeed take place when credit growth picks up. “We believe transmission of rates will happen gradually over the next few months,” Bhattacharya said.

Complaining that banks were not passing on the rate benefit to industry, Harshavardhan Neotia, president of Federation of Indian Chambers of Commerce and Industry (FICCI), said the RBI should have cut rates.

“The government’s decision to stick to the inflation target of 4 per cent is another positive. In this context, a further push to demand through lowering of interest rates would have translated into higher investments,” Neotia said.