• JUNE 3, 2014

Monetary Policy: In no hurry to cut rates!

In-line with the new government's thrust to revive economic growth; the Reserve Bank of India Governor Raghuram Rajan left the key benchmark lending rates unchanged in its second bi-monthly monetary policy FY15 review today.

Policy stance

The Reserve Bank of India (RBI) has maintained a status-quo on key lending rates. The repo rate or the rate at which the Central Bank lends money to commercial banks remains unchanged at 8.0%. Cash reserve ratio or CRR is also kept unchanged at 4.0%. However, the key highlight of the policy review has been the reduction in statutory liquidity ratio or SLR by 0.5% from 23% earlier to 22.5%.

While the food inflation has remained stubborn, the CPI inflation excluding food and fuel has been moving downwards. The CPI has come down this year post several tightening measures by the central bank. But the risks to retail inflation (currently around 8%) remain on account of El Nino effects, geopolitical tensions and the impact on fuel prices. That said, the risks to CPI inflation are largely expected to get offset by the stronger government action on food supply and better fiscal consolidation going forward.

Keeping in view the sluggishness in economic activity and the sticky inflation rate, it was imperative on the part of the central bank to hold the key policy rates. Moreover, the fragile credit scenario warranted more capital headroom for banks. The SLR reduction is expected to infuse Rs 200 bn liquidity into the system thus helping ease capital concerns for banks.

Economic scenario

While the growth is gaining traction in the West, the emerging markets have been bogged down by the structural constraints. Back home, the consumption and the investment demand continues to remain weak and consequently the poor credit growth persists.

The CPI in April had accelerated to 8.6% primarily driven by higher food prices. Moreover, India's industrial production (IIP) has shrunk for the second time in row by 0.5% on account of weak consumer demand and poor capital investments. Not just that, the GDP growth has slowed down to 4.7% in FY14 as against the estimate of 4.9%. This becomes the second consecutive year of sub-5% growth for the Indian economy. It is the worst slowdown in the decade.

The way forward....

While the RBI has done its bit to boost the credit off-take and address inflationary pressures, the ball in now in the government's court. Reducing supply side pressures by trimming subsidies is obligatory for the government to yield the desired results.

The central bank aims to bring down the inflationary levels to 8% by January 2015 and 6% by January 2016. However it would be too premature to estimate the impact of reforms on RBI's policy stance since global cues and geo-political risks can also play a part.

Lower interest rate cycle...around the corner?

We believe, the RBI, given its conservative stance, is unlikely to be in a hurry to cut rates. Which in turn means that investors and corporate looking forward to the lower interest rate cycle will have to be patient. Until and unless the new government can reasonably assure the central bank of its actions to keep prices rise under control, the governor may not relent. And hence it will be too risky to speculate on whether we are on the cusp of reversal in interest rate cycle.

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