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Reserve Bank of India Governor Raghuram Rajan increased the repo rate by 25 basis points. However, he insists banks' cost of fund is set to decline, as the marginal standing facility (MSF) rate has been reduced by 75 basis points. Excerpts of his speech at his maiden monetary policy review:
On the 25-basis-point rise in repo rate:
We have announced our intention to return to normal monetary operations, where the repo rate will return to being the effective policy rate and liquidity conditions need not be as tight as they currently are. Let me emphasise the difference between the MSF and repo rate will be brought down to 100 basis points. At the same time, recognising inflationary pressures are mounting and determined to establish a nominal anchor that allows us to preserve the internal value of the rupee, we have raised the repo rate by 25 basis points. The intent is when the repo rate becomes the effective policy rate, it should be consistent with inflationary conditions in the economy.
On further rises in repo rate:
Let me say we do not have in mind what the next move on repo rate should be. It will be tailored to economic conditions. The intent of today's (Friday's) move was to ward off escalating expectations of inflation. The pace of the disinflationary process has to be calibrated...I want to be entirely neutral at this point on what the next step could be.
On a possible revision in RBI's inflation forecast for 2013-14:
The events over the last few weeks clearly had an impact on what we think our forecast on inflation is, at this point. Take the rupee depreciation; take the temporary higher price of oil, etc. These are all issues that will affect inflation and, of course, suppressed inflation is also being let in. I think that is a good thing; it will be one-off, and not permanently increase the rate of inflation. But those are factors that change inflation and inflationary expectations. So, we have to worry about some of these factors...What I would like to see is we achieve RBI's target of bringing WPI (Wholesale Price Index) inflation to below five per cent. Urjit Patel's committee, over the next three months, will contemplate what else we should be thinking about. We want to fight against inflation, and we will bring it down. But it is not a take-no-prisoner kind of stance.
On the repo rate rise affecting economic growth:
We have to be careful about immediately associating a repo rate rise to growth implications. Sometimes, the knowledge that inflation will be lower can actually enhance growth prospects. So, I don't think it is correct to immediately conclude this is negative for growth. Also, remember it is clubbed with a substantial reduction in the MSF, which is growth-positive. I also believe from the growth perspective, there are other, more important factors that will come in over time, including project completion, power generation, the availability of power, the kharif crop and the sentiment in rural areas. So, I will not overestimate the effects of a 25-basis-point repo rate increase.
On banks' cost of fund:
On net, these measures will reduce the cost of banks' financing substantially, while allowing us to take an appropriately precautionary stance on inflation. The 75-basis-point MSF rate cut we have announced today affects a significant quantum of funds that are borrowed from the markets through wholesale deposits, bulk deposits, etc. This also reduces banks' cost of funding significantly. Now, set against that, my sense was the 25-basis-point increase in the repo rate would basically affect the borrowings under LAF (liquidity adjustment facility). So, the immediate effect of what we have done is going to reduce banks' cost of funding.
On whether banks would increase lending rates:
I expect them to set rates appropriate to their cost of funding. I hope to make decisions, they will look at their cost of funding and see how that has changed, not look into the future and try and anticipate some hypothetical cost. They should look at their current cost. My sense is that's what most banks do. I don't want to micro-manage that process. To that point, right now, the repo rate increase of 25 basis points basically affects 0.5 per cent of the entire borrowing of the banking system. So, 0.5 per cent of 0.25 per cent is a very small number. Also, the cut in the MSF rate would offset any effect of the repo rate rise...I think in terms of today's policy action, the central factor has been to bring down their costs, rather than increase their cost of funding.
On the demand to abolish CRR:
Let me emphasise this is made out to be a much bigger hardship than what it is. When we looked at the past data, we found they maintained 102 per cent. We had said 99 per cent; so, it was below the level that they used to maintain. To act as if there is a big increase in cost is completely overstating the fact. We have, in the interest of allowing them easier management, reduced it to 95 per cent. Remember, CRR (cash reserve ratio) is maintained with historic regard. It is not prospective; it is based on a number they already know. So, for them to say there is tremendous hardship in maintaining 99 per cent is, I think, overstating the fact. We have, however, taken their worries into account and reduced those somewhat. My sense is at this point, further reduction is not contemplated. Let me emphasise this is peanuts in the larger scheme of things. So, the amount of attention that has gone into this particular issue, I think, is unwarranted.
On US Fed's decision to delay tapering QE:
Let us remember the postponement of tapering is only that - a postponement. I think in the short term, it has postponed some of the concerns. But my sense is markets were quite prepared for a moderate tapering and what this has done is, in a sense, created the possibility of uncertainty down the line...We must use this time to create a bulletproof national balance sheet. Let's not lose a chance---the warning that we have been given---and celebrate too early because this is going to come back. What we need to do is put our house in order before it comes back.
On the preparedness to offset the eventual impact of QE tapering:
I think we have already taken a number of measures. Now, those measures will play out. We will see the money flowing in through the FCNR (B), or foreign currency non-resident (B), swap through the banks' tier-I capital arrangement and in other forms. I think to some extent, it will offset any potential for outflows down the line. So, I don't think we need to contemplate a whole new set of measures. Obviously, we have to watch and if these don't play out as anticipated, we will have to think of what else we need to do. But at this point, I feel fairly confident the measures are adequate.
On the rupee's current level:
We are more comfortable now because we feel there was a certain amount of panic in the market that was entirely unwarranted and driven by certain unfounded apprehensions. So, I am absolutely more comfortable with where we are now than where we were a couple of weeks ago.
On opening up the bond market:
I think we have already seen one measure from Sebi (Securities and Exchange Board of India) to open the bond market. They eliminated the auction G-sec investors had to participate in from outside, if they wanted a piece of the G-sec market. I think that was a very good move. There is some talk about bringing India into some of these bond indices. What needs to be done? We will have conversations with international index agencies and some of the investment banks that create these indices. Let us see what they require. Sometimes, they require a pace we have to examine before we can be comfortable with it. But we will have the conversations. I think a big step forward was the Sebi taking off the auctions, which was a hindrance to our moving onto these indices. Let us see what it takes to get on some of these indices.
