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Rajan opens door for rate cut early next year

Reserve Bank of India (RBI) Governor Raghuram Rajan on Tuesday held interest rates steady on Tuesday but held out hope for industry by saying it could ease monetary policy early next year – even outside the policy review cycle — if the downward momentum in inflation continued, and fiscal developments were encouraging.

“(It is a) misconception among corporates that RBI is unconcerned about growth,” Rajan said at a press conference after the policy announcement. But keeping up with his inflation-warrior image, Rajan defended the status quo on rates, saying that he did not want to do a “flip-flop” on it and is looking for “certainty” on various factors, mainly inflation, before lowering the key interest rate.

“We have to make sure that the disinflation process is well underway. We have had a couple of months (of low inflation) after five years of high inflation. We want to make sure that this is for real especially because we don’t intend to flip-flop,” Rajan said.

The repo rate was kept unchanged at 8% — a fifth straight bi-monthly monetary policy review in which the status quo was maintained. The central bank also kept the key ratios — the cash reserve ratio and the statutory liquidity ratio — unchanged.
The decision was broadly in line with expectations as most economists and market analysts had expected the repo rate — the rate at which the central bank lends to banks — to remain unchanged, given the governor’s insistence on quelling inflation first.

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Most analysts, however, said said the RBI’s idiom has changed from whether it would cut rates to when. The RBI’s next policy review is in early February and most expect the central bank would either cut interest rates then or wait until April.

State Bank of India Chairman Arundhati Bhattacharya said by advancing the inflation target of 6% to March 2015, the RBI has now set out a clear message of the reversal of the rate cycle, sooner than later. With oil prices at historic lows, a stable exchange rate and strong capital inflows, the feel good factor is here to stay.

The RBI said “still weak demand and the rapid pace of recent disinflation are factors supporting monetary accommodation. However, the weak transmission by banks of the recent fall in money market rates into lending rates suggests monetary policy shifts will primarily have signalling effects for a while.”

Rajan put it more bluntly at the press conference, saying: “It is not my job to tell banks what to do. Though rates have come down, they have not passed it on.”

The RBI has set a target of eight% retail inflation by January 2015 and 6% a year from then. Retail inflation had hit a lifetime low of 5.52% in October (the series was launched in February 2012), while Wholesale Price Index-based inflation slumped to a five-year low of 1.77% in the same month, driven by softening prices of fuel and food items.

With Consumer Price Index-based, or retail, inflation already within RBI’s target, Rajan had hinted in the past that he would like to tackle the issue once and for all. Also, the overhang from a weaker-than-normal monsoon, which could put pressure on food prices, has not been entirely ruled out.

In its statement, the RBI spoke of the need to revive capital investment, and called on the government, which will announce its Budget in February, to “stay on course” to meet fiscal deficit targets. Those targets have been jeopardised by weak tax revenue growth and the slow pace in selling off stakes in state-run companies to raise funds.

ALSO READ: CEOs expect RBI to cut rates by February

Tuesday’s decision, however, is likely to disappoint Finance Minister Arun Jaitley, who has been batting for lower interest rates to further boost economic growth, as well as sections of Indian industry.

Rajan also said corporate groups are often asked to pay higher interest rates because of their poor financials and inability to repay existing dues.

“I also see that there is a whole lot of confusion. The immense risk premium that is being demanded of some corporates is because of the state of their leverage, because of the risks they have taken, and because of their inability or unwillingness to repay. This should not be attributed to RBI. What we control is risk free rate, what they can control is the risk premium that is demanded of them. This is something that they should work on even as we are working on bringing down inflation and risk free rate that they have to pay,” Rajan said.

The RBI kept its central estimate for growth at 5.5% while revising its inflation projection down to 6% by March-end FY15. In the medium term, RBI expects inflation to hover around 6% assuming a normal south-west monsoon, lower crude oil prices and no change in administered prices barring electricity.

The RBI governor also mentioned that the central bank was in the process of finalizing the monetary policy framework, and the government seems comfortable with adopting a target of around 4% with a band of +/-2% beyond 2016.

After having dismantled the gold import curbs over the week, Rajan did not sound much concerned over the high imports of gold, saying that the dip in crude prices creates some room in the current account. The move to do away with the 80:20 rule on gold imports was initiated from the government’s side and was a “reasonable” one, he added.

Industry was disappointed. Confederation of Indian Industries President Ajay S Shriram said at this juncture, even a symbolic cut in policy rates would have sent a strong signal. “CII the RBI would move in favour of growth in its next monetary policy and the new year would witness a cut in policy rates by at least 50 basis points,” he added.

The stock markets also reacted negatively as the Sensex dipped 116 points. But the government bond yields dropped sharply and fell below the 8% mark due to dovish statements made by the central bank. he yield on the 10-year bond ended at 7.97% compared with previous close of 8.06%.

ALSO READ: Rajan scores one for the RBI’s independence

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