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The reason behind the cut in policy rate seems to be a slowing economy, not something to be excited about
Reserve Bank of India (RBI) governor Raghuram Rajan surprised financial markets by lowering the policy repo rate by 25 basis points to 7.5 per cent. This is the second time that the governor announced the cut outside official policy meetings. While market did expect the central bank to continue on the path of interest rate cuts, the timing came as a surprise. For some, it is not so much of a positive surprise.
Commenting on the development Abheek Barua, chief economist at HDFC Bank said "I am a little surprised that they did it today because I think they just sort of followed up on the January precedent and did it out of the policy, which I don't think is necessarily a good thing. It introduces a lot more volatility in the markets, than when the rate cuts were coming on a formal platform.”
Barua went on to say that if there is positive data flow and if the governor does not reduce rates, then there might be a sell-off. “So you're sort of building a lot of expectation around a very reactive policy, which I don't think is a good thing” he adds.
Further, the reason behind the cut in policy rate seems to be a slowing economy, not something to be excited about. Rajan is clearly not happy with the revised GDP numbers. In his statement, he has pointed out that the picture the GDP number presents is at odds with still-low direct measures of growth of production, credit, imports and capacity utilisation as well as with the anecdotal evidence on the state of the economic cycle.
So, if Rajan was not happy with the overall picture why did he reduce interest rates?
The reason cited by Rajan is exactly opposite to what the GDP numbers reveal. Rajan has cited two reasons to justify acting outside the policy review cycle. First, he says, is the still weak state of certain sectors of the economy as well as the global trend towards easing suggests that any policy action should be anticipatory once sufficient data support the policy stance. And second, with the release of the agreement on the monetary policy framework, it is appropriate for the Reserve Bank to offer guidance on how it will implement the mandate.
In short, he is saying that the economy continues to be weak despite whatever number the government prints and second that the government in its budget has demonstrated they will behave themselves in fiscal consolidation.
There is however, one hurdle in transmitting the governor’s policy stance to the ground. None of the larger banks have yet passed on the previous rate cut announced by RBI. In fact, after the previous cuts were announced, banks went ahead and announced a deposit rate cut.
Clearly the assumption that a cut in interest rate will improve quality of asset and spur growth is wrong because banks are just not passing the benefit to the consumers.
Rajan in his statement has said: "Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation."
Bankers by not reducing the rates and being cautious on account of high toxic loans are impacting credit off-takes. On the other hand, they are trying to capitalise on the situation by reducing cost of funds and keeping the cost of advances high.
In an interview to CNBC, P Pradeep Kumar, managing director, SBI said any cut in repo rate should automatically trigger a cut in deposit rates. But about cut in lending rates, he said the asset liability management committee would perhaps meet late in the week and take a call on cutting the rates.
Some of the smaller banks are indicating that they will reduce interest rate to align themselves with the external environment.
Analysts are expecting another 75 basis point cut by the central banker in the current calendar year. Banks will have to pass on the benefit to the customers in such a scenario.
