Big rate cut: Rajan to watch prices after 50 basis point bonanza

Big rate cut: Rajan to watch prices after 50 basis point bonanza

MUMBAI — The Reserve Bank of India on Tuesday cut its benchmark policy rate by 50 basis points to 6.75%. This might be the last incentive market players will see from the country’s central bank through the end of the fiscal year. With the “front loaded” move, the bank has accommodated a likely spike in consumer prices during the next three to four months. And it is likely to be patient while banks pass on the benefits of the rate cut to their borrowers.

     So far in 2015, India’s central bank has slashed its overnight lending rate, or repo rate, by 125 basis points. With the 50 basis point cut on Tuesday, the repo rate now stands at a four-and-a-half year low.

     The bank left the cash reserve ratio unchanged at 4%.

     The RBI is hoping that by easing borrowing costs for individuals and corporations alike, it can piggyback record-low inflation and kindle economic growth.

     Headline consumer price inflation in August softened to 3.66% from 3.69% in July, mainly thanks to falling commodity prices around the world.

     “Since our last review, the bulk of our conditions for further accommodation have been met,” the RBI said in its Fourth Bi-Monthly Monetary Policy Statement, 2015-16. “The January 2016 target of 6% inflation is likely to be achieved. … Therefore, the focus should now shift to bringing inflation to around 5% by the end of fiscal 2016-17.”

     Reserve Bank Gov. Raghuram Rajan, however, made it clear that although inflation is at comfortable levels, concerns remain. Inflation may have already started rising, he said, due to the base effect — a situation in which abnormally high or low levels of inflation one month distorts headline inflation numbers for the most recent month.

     Rajan said growth prospects in emerging market economies remain weak even though the U.S Federal Reserve earlier this month somewhat bolstered financial markets around the world by holding off on raising its own policy rate.

     “In India, a tentative economic recovery is underway but is still far from robust,” Rajan said. He added that the central bank will now focus on working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis point cut are removed.

     Rajan also slightly reduced India’s growth forecast for 2015-16, from 7.6% to 7.4%. He blamed slower-than-expected global growth and trade, a lack of appetite for new investments, and poor business confidence.

     According to Sunil Sinha of India Ratings, the the RBI is likely to decide whether to further adjust key interest rates only after next year’s general budget is written.

     “By then,” Sinha said, “it will have clarity on inflation and the government’s fiscal position.”

     Sinha added that the RBI described its latest move as “front loading” to show that it is now implementing policy that it believes will be necessary down the road. “Any further action,” Sinha said, “depends on how the consumer price index behaves beyond the financial year.”

     Ratings agency ICRA also believes that while the focus has been shifted to raising the inflation rate to 5% by the fourth quarter of fiscal 2017, the fiscal and inflationary impact of an upcoming revision in how government employees get paid remains uncertain. This suggests a low likelihood of further easing in the near term.

     The country’s largest bank, the State Bank of India, immediately reacted to the repo rate cut, trimming its base lending rate by 40 basis points.

     HDFC Bank, ICICI Bank and other leading lenders hinted that they would make trims of their own.

     Chanda Kochhar, managing director and chief executive of ICICI Bank, said her institution would likely pass on more than half of the RBI’s rate cut to its borrowers.

     Analysts at Credit Rating Information Services of India reckon that credit growth may gradually pick up in the latter half of the financial year ending March, driven by a rise in automobile and home loans as well as public-sector investments. The agency sees overall credit growth increasing to 13% to 15% in 2015-16 against around 12.2% in 2014-15.

     The analysts also expect deposits to increase 13% to 15% in 2015-16, compared with a 12.6% rise in 2014-15, backed by an expected pickup in economic growth and higher disposable income, the result of low inflation.

     “While lower borrowing costs would be of help to many excessively leveraged borrowers,” Societe Generale’s K Kundu said, “the fact remains that investment activity in India remains weak not because of borrowing costs being potentially higher by 50 to 75 basis points but because the overall operating environment remains weak and legislative reforms have virtually come to a standstill.”

     Rajan’s rate cut did find favor with Indian industry. The interest rate cut will not only translate into cheaper loans for corporations but also for those aspiring to finance homes and cars, observers said.

     “This cut comes as a balm for anxious markets,” said V.S Parthasarathy, chief financial officer of the Mahindra Group. “The industry’s expectation of a turnaround in demand led by growth in the second half will now be well anchored.”

     The Confederation of Indian Industry also praised the RBI’s move. Considerable uncertainty in regard to the direction of borrowing costs has now been removed, it said. The corporate sector will now be in a better position to drive investment and growth recoveries, the industry body added.

     Indian stocks and the country’s currency staked out small gains after the RBI’s move. The Bombay Stock Exchange’s benchmark Sensex index climbed 0.63% to close Tuesday at 25,778.66, while the Indian rupee finished the day’s trading at 65.96, up 0.14% from Monday’s close.

     Stocks of companies in the interest rate sensitive banking, realty and automotive sectors were the index’s top performers. The BSE Bank Index rose 0.9%, the BSE Realty index rose 1.99% and the BSE Auto index gained 0.76%.

Big rate cut: Rajan to watch prices after 50 basis point bonanza