What next after RBI cuts rate for third time in 2015?

June 2, 2015

(Any opinions expressed here are those of the author and not of Thomson Reuters)

The Reserve Bank of India (RBI) Governor Raghuram Rajan listens to a question during a news conference, after the bi-monthly monetary policy review, in MumbaiThe Reserve Bank of India (RBI) on Tuesday cut its benchmark repo rate by 25 bps to 7.25 percent while maintaining the cash reserve ratio (CRR) steady at 4 percent and the statutory liquidity ratio (SLR) at 21.5 percent.

The central bank also reduced its growth forecast for India in the current fiscal to 7.6 percent from its earlier 7.8 percent in April. Inflation is expected to remain low due to base effects till August, then start rising to about 6 percent by January 2016.

Stock markets reacted negatively to these announcements, even though a 25 bps cut was expected. Governor Raghuram Rajan’s outlook on the economy is being interpreted as cautious by investors. Monsoon, oil prices and external volatility are key risks to inflation while consumption demand may be hampered by a higher services tax rate. Rajan also said weak results from the corporate sector suggest “final demand is yet to pick up strongly”.

The RBI said it had front-loaded interest cuts, which means that the central bank may be on an extended pause after Tuesday and the next rate cut is unlikely to come until end-2016.

The RBI said banks should pass through the sequence of rate cuts into lending rates, but that is unlikely to happen because the central bank did not take steps to free up liquidity. There is also a slight possibility of a rate hike at the end of the year if inflation climbs.

By the time the RBI holds its next policy review on August 4, we would have more clarity on how monsoon is panning out and external factors like the impending U.S. rate hike, Greece’s debt problem, etc.

The RBI has already cut repo rate by 75 basis points in three instalments in 2015; but for investments to pick up, lenders should pass on at least 50 basis points of the rate cuts to consumers.

Rajan has done his job. It is now up to the lenders and the government to take cues from the policy announcements and implement the needful.

 

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