General Awareness

April 04, 2017 @ 01:15 PM

Rate Cut Heralds Shift in RBI's Monetary Policy Stance

 Published : Monday, 19 January, 2015 01:20 PM
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Rate Cut Heralds Shift in RBI’s Monetary Policy Stance
On January 15, 2015, the Reserve Bank of India surprised markets with a benchmark interest rate cut of 25 basis points to 7.75% from 8%, its first reduction since May 2013. The RBI, however, kept the cash reserve ratio unchanged at 4.0%. Following reduction in the repo rate, the reverse repo rate has been adjusted to 6.75% and the marginal standing facility rate and Bank Rate to 8.75%. The central bank’s move came a day after government data showed wholesale price inflation (WPI) in December 2014 rose 0.11% annually, much lower than the 0.6% rise forecast by economists. 
The Consumer Price Index (CPI) has been easing since July 2014, according to the RBI, and is below the expected trajectory. The government too has reiterated its commitment to adhering to 4.1% fiscal deficit target. Overall, all these factors have created a comfort zone for the RBI to opt for an early rate cut.
RBI governor RaghuramRajan was dubbed hawkish by industry and in policy circles following his tough stance on rate cut amid easing inflation as he resisted several calls from various quarters including the government. Although he had hinted in December that easing inflation could provide the bank leeway, Rajan chose the timing after he was convinced that the inflationary pressures were benign and would remain below the central bank’s target. 
The inflation rate in India was recorded at 5% in December 2014 marginally up from a record low of 4.38% in November a month earlier. This is when inflation rate in the country has averaged 8.98% from 2012 until 2014, reaching an all-time high of 11.16% in November 2013. The 5% inflation rate meets the RBI’s target of below 8% inflation in January 2015 and 6% for January 2016. The ground had been prepared for a change in RBI's stance by the near 55% fall in the price of crude oil since June 2014 and the sharp moderation in both retail and wholesale price inflation. 
The expected pressure on food prices also did not take place as expected as supplies remained stable. Oil prices are expected to remain soft for now and inflationary pressures are expected to remain muted. What should bring cheers to both individuals and investors alike is that the RBI functionaries have said that once the monetary policy stance shifts, subsequent actions would be consistent with it.
By cutting the repo rate, the RBI has essentially signaled that inflation is dying and that growth needs a push. It can be said that the central bank’s stance on rate cut has shifted. Not surprisingly, the Bombay Stock Exchange’s (BSE) key benchmark index Sensex registered a strong rally of 729 points in a single day on January 15, which is its highest in over five years. The rally was led by rate sensitive stocks like banks, financial services, real estate, capital goods, and auto stocks.
A falling interest rate regime is good for both individuals and investors. A cut in interest rate means banks can lower their rate of interest for lending which, in turn, can lead to higher demand for loans for customers and companies. The move is also expected to revive capital investments in Asia’s third largest economy although India Inc. expects at least a one percentage point rate cut to revive growth in the industry and demand in the economy. In financial markets, a shift in RBI stance could trigger fund managers and retail investors to invest in long-term debt schemes, fixed deposits and recurring deposits. 
Interest burden on the government will ease up and if the fiscal deficit is cut more slowly, it could boost public investment. Corporate India can swap its higher cost debt with cheaper money. Banks will be able to raise capital more cheaply and also fresh equity to strengthen their balance sheets. For individuals reeling under inflation and high interest regime, home and auto loan rates will likely ease. Reduced fuel bill has already halved the burden.
With that said, the rate cut may not enthuse big corporate investors as much as greater clarity on policy measures like land acquisition, insurance sector, multi-brand retail and others which still require parliamentary nod. Although the government has issued executive decrees, it still needs legislative approval. There is an added concern: while the RBI has modestly eased policy rates and may further reduce a few points ahead or after the union budget in February 2015, the central bank remains wary of capital flight when the U.S. changes its monetary stance sometime in mid or late 2015.
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