Breaking the news of the day, the RBI Governor slashed the Repo Rate by 50 basis points (bps) or 0.5%, from 7.25% to 6.75%. Repo rate is the rate at which Indian Commercial banks borrow funds from the Central Bank in the event of a shortfall. The markets cheered the announcement with Nifty and Bank Nifty closing up by 0.6% and 1%, at 7,843.30 and 17,281.20 respectively.
The aggressive stance of the RBI is indicative of a low interest rate regime going forward. Today’s cut takes the total rate cuts in this financial year to 125 bps. With India witnessing benign inflation, close to 5% (well under RBI’s target of 6% by January 2016), the RBI has granted the Government, Corporate India and Banks their wish for a deeper rate cut. The only dampener – is the cut in RBI’s projected growth rate for FY 16, from 7.6% to 7.4%.
The RBI seal pictured outside its head office in Mumbai
For the last 3 months, everyone from finance ministry officials, bank honchos and industrialists have been pushing Governor Rajan for a rate cut. All this was in anticipation to give greater headroom to consumers and corporates to consume and invest respectively. The demand for rate cuts had been at its peak, in spite of repeated advise by Governor Rajan to corporates to focus on strengthening their products and markets, to the Govt. to work on eliminating red tape and ushering in policy reforms, and to the banks to take care of and avoid bad loans (Non- performing assets).
But who likes accountability ? The fingers were always pointed at the Reserve Bank.
Rate Cut Done, Go to Work Now –
Now the Governor, man of the moment, has smashed the ball into the critics’ court in a subtle manner, by choosing to treat them with an unexpected deeper cut in rates. It is now up to the core parties – the manufacturers, service providers, financiers and Government to own responsibility and push the throttle to drive growth. Mr. Raghuram Rajan has left them with no excuse, and they now stand exposed if people don’t see results.
A Diwali Gift ?
Well coming back to the party, the Governor may have presented the borrowers and the bondholders with an early Diwali gift. A significant repo rate cut will likely bring down the common man’s EMI on personal and housing loan. The rate will no doubt help in boosting demand for white goods and automobiles. The bondholders stand to gain by appreciation in their securities because of a resultant decline in bond yields. (In fact, the bond yield of 2025 Rupee Bond today saw a decline of 1.77% to close at 7.590%). The event marks that RBI sees inflation under control in the foreseeable future.
Gentlemen: Governor (centre) with Deputy Governors (L-R) Dr Urjit R. Patel,
Shri S. S. Mundra, Shri Harun R. Khan, Shri R. Gandhi
A Question remains –
A question that still lingers is by when the benefit of rate cut will be transmitted to the beneficiaries. Of the 75 bps cut this calendar year (till yesterday) off the repo rate, only 35 bps have been transmitted to the customers. The banks say they will fully pass on the rate cut when their cost of funds comes down, but by when is something there is not much clarity about. The Finance Minister and Bank Chiefs, however, have reassured they would ensure the monetary transmission takes place fast. The Bank credit growth is witnessing a steep decline with just a 9.3% increase in June 2015, which is the lowest loan demand in almost twenty years.
Can Rate Cuts make India’s growth reach double digits ?
It is best to keep in mind that monetary policy remains a cosmetic unless Govt. and Industry work in tandem and hit the ground running. A couple of percentage points in either direction would not make up for hardcore production, employment and enterprise. It sure helps to secure capital at cheaper rates but land, labour and taxation reforms are required for any uptick in business sentiment and in an extension to economic growth.
Views presented in the article are those of the author and not of ED.