“It’s not just a rate cut; it also signals a shift in the stance of monetary policy,” Arvind Subramanian, chief economic advisor to the finance ministry, told reporters.
The central bank also hinted as much, saying inflationary pressures had ebbed since July last year and on current policy settings, inflation was likely to be below six per cent by January 2016. “These developments have provided headroom for a shift in the monetary policy stance,” RBI said, before delivering a surprise Makar Sankranti and Pongal gift by cutting the repo rate, its key lending rate, by 25 basis points (bps) to 7.75 per cent. Consequently, the reverse repo rate, at which the central bank drains excess liquidity from the banking system, also fell 25 bps to 6.75 per cent.
The rate cut, the first in 20 months, came 15 days ahead of a scheduled policy meeting of the central bank on February 3. (Reason for cheer)
Bankers and market players have already started factoring in a deep cut in the repo rate this year, with estimates ranging from 50 bps to as much as 125 bps. State Bank of India (SBI) Chairman Arundhati Bhattacharya said, “This cut might be just the beginning of a rate easing cycle.” HDFC Bank and Standard Chartered said they expected at least two more rate cuts, totalling 50 bps, this year. Others such as Morgan Stanley put the figure at 125 bps.
Finance Minister Arun Jaitley, who earlier this week said the time was right for lower rates, welcomed the cut, saying it would help revive capital investment and lead to more money in the hands of consumers.
It is expected bankers, who met the finance minister for pre-Budget discussions later in the day, will quickly take their cue from RBI and start cutting lending rates. While two government banks, Union Bank and United Bank of India, have reduced their base rates by 25 bps, most other banks have said it is only a matter of time before they cut rates and that their asset-liability committees would meet soon to take a decision on the matter. YES Bank said it would cut its minimum lending rate by the end of this month.
SBI, however, did not comment on when it would decide to reduce its base rate, currently 10 per cent.
RBI’s surprise move led to euphoria in the markets. Benchmark indices posted record gains, with the BSE Sensex soaring 729 points, or 2.66 per cent, and all its sectoral indices ending in the green.
While the bond market also saw a rally, the rupee appreciated against the dollar due to gains in equities. The yield on the 10-year benchmark bond dropped to 7.66 per cent on Thursday, before closing at 7.70 per cent, compared with its previous close of 7.77 per cent. The rupee appreciated to 61.48/dollar in intra-day trade but due to dollar-buying by state-run banks, possibly on behalf of the central bank, the currency ended at 62.07, compared with its previous close of 62.19.
Corporate leaders expect more rate cuts in the coming months to help revive growth and start projects. Godrej Group Chairman Adi Godrej said while the rate cut would lead to increased investment and demand for residential housing, automobiles, consumer durables, etc, which were financed by banks, a further rate reduction of 300 bps was required during the year.
The central bank, of course, sought to link further moves in this regard to government action on stemming the fiscal deficit and addressing infrastructure bottlenecks. “Data that confirm continuing disinflationary pressures is key to further easing. Also critical will be sustained high-quality fiscal consolidation, steps to overcome supply constraints and assured availability of key inputs such as power, land, minerals and infrastructure,” RBI said.
In this context, analysts said Budget 2015-16, to be presented next month, could decide the course of monetary policy through its stance on fiscal consolidation. The early rate reduction now puts the onus on the government to make credible efforts to contain its fiscal deficit, while pursuing policies aimed at boosting investment and improving infrastructure to fire up the economy.