30.9.15

RBI surprises with a bigger rate cut than anticipated

It was a throwaway line by the Reserve Bank of India governor at his press conference but it was spot on: “I'm Raghuram Rajan and I do what I do.“ It exemplified RBI's monetary policy action on Tuesday -a rate cut that was deeper than expected from a man who's made the war on inflation his main focus. That was accompanied by a number of measures aimed at bolstering the monetary policy framework, improving the efficiency of the banking system, broadening and deepening the financial markets, coping with stressed corporate and financial assets and widening access to financial services. In so doing, the bank went a long way toward setting India on the path of lower interest rates. “The Reserve Bank has front-loaded policy action“ because a lot of things are going India's way , except perhaps for the monsoon, Rajan said, indicating that the rate-reduction cycle hadn't necessarily come to an end. But he made the point that cuts need to be transmitted to the broader economy to have real effect.
“While the Reserve Bank's stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut (since January) in the policy rate are removed,“ Rajan said. In a vote of confidence, stocks and bonds rose while the rupee strengthened, generally unusual behaviour for a currency in the context of a rate cut.
The government and industry welcomed the move and pledged support.
Banks responded by paring rates and the government said it would do what was needed to ensure fiscal discipline was maintained and prices were kept under check.
“The government is fully committed in meeting the fiscal deficit targets in order to consolidate the gains achieved by the contained inflation,“ Finance Minister Arun Jaitley said at a press conference. “There will be a need to have a constant vigilance now on the inflation front.“
Though prices have slowed dramatically in the recent past, RBI's focus won't waver.
“The Reserve Bank will continue to be vigilant for signs that monetary policy adjustments are needed to keep the economy on the target disinflationary path,“ he said. “Given our year ahead projections of inflation, this ensures one-year expected treasury bill real interest rates of about 1.5-2.0%, which are appropriate for this stage of the recovery.“

The poor investment climate and lack of demand led the central bank to lower its economic growth forecast by 20 basis points to 7.4% from 7.6%. The central bank cut the repo rate at which it lends to banks by 50 basis points, or half a percentage point, compared with the overwhelming expectation of 25 basis points, to 6.75%, the lowest in four-and-a-half years.
Apart from this, the governor said foreigners will be allowed to buy more government bonds, effectively pushing rates lower, and the regulator will work with the government to bring down interest rates on small savings. Banks have blamed this for keeping them from reducing lending rates.
The central bank kept aside fears of inflation rearing up again as it sees a weakening global economy as the bigger threat. It forecast inflation for January 2017 at 5%, in line with its target, which means policy rates could be cut by another 50 basis points in the next 12 months if the trajectory on prices is maintained. The sharper-than-expected cut will buoy sentiment.
“Investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow,“ Rajan said.

Benchmark government bonds had one of their best days in recent times with yields tumbling 12 basis points to 7.61%. Bond yields and prices move in opposite directions.The rupee gained 0.15% against the dollar to 65.95.
Rajan, who has waged a relentless battle against inflation, has for the first time in more than two years since taking over expressed confidence that the consumer price index could glide to the January 2017 estimate cited above and manage to reach the 4% medium-term target.
Rajan was in accord with US Federal Reserve chair Janet Yellen on developments in China having a deleterious effect on the global economy. He pointed out that the “Federal Reserve has postponed policy normalisation“, a move that may have played into his decision, as did lack of investment.

No comments: