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Nachiket Kelkar
Nachiket Kelkar

Lending rate

RBI cuts repo rate; with inflation likely to rise, experts see few cuts ahead

urjit-patel-rbi-guv RBI Governor Urjit Patel along with deputy governors arrive for a press conference to announce the RBI monetary policy, in Mumbai | PTI
  • RBI raised concerns over the weakening industrial performance, highlighting that the weakness in the capex cycle was also evident in the number of new investment announcements falling to a 12-year low in the first quarter

The Reserve Bank of India on Wednesday expectedly reduced the benchmark repo rate by 0.25 per cent (25 basis points), citing a sharp drop in retail inflation and a weakening industrial performance.

However, with inflation expected to pickup in the second half, experts see limited room for rate cuts going ahead.

After keeping rates on hold at 6.25 per cent for four consecutive monetary policies, the central bank has cut the rate to six per cent, a six-and-a-half-year low. Consequently, the reverse repo rate will now stand adjusted to 5.75 per cent and the marginal standing facility (MSF) rate and the bank rate at 6.25 per cent.

Repo rate is the rate at which RBI lends funds to commercial banks, while reverse repo is the rate the RBI offers to banks which deposit their surplus funds with the central bank.

Five members of the monetary policy committee were in favour of a rate cut now, while one was in favour of maintaining a status quo.

Why a rate cut now?

“Some of the upside risks to inflation have either reduced or not materialised—the baseline path of headline inflation excluding the HRA (house rent allowance) impact has fallen below the projection made in June to a little above four per cent by Q4; inflation excluding food and fuel has fallen significantly over the past three months; the roll-out of the GST (Goods and Services Tax) has been smooth and the monsoon normal. Consequently some space has opened up for monetary policy accommodation,” RBI noted.

The RBI has a medium-term target to maintain CPI inflation at four per cent, within a band of plus or minus two per cent.

Data released by the government last month showed CPI inflation slowed to 1.54 per cent in June, from 2.18 per cent in May.

RBI Governor Urjit Patel said it was a “calibrated policy decision” to cut rates by 25 bps given the drop in inflation and “it was an opportune time” to do so now and then wait for more data, given that future inflation trajectory is uncertain.

At the same time, India's industrial production has also slowed. Growth in IIP in May slipped to 1.7 per cent, versus 3.1 per cent in April.

RBI raised concerns over the weakening industrial performance, highlighting that the weakness in the capex cycle was also evident in the number of new investment announcements falling to a 12-year low in the first quarter.

“There is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all. This hinges on speedier clearance of projects by the States,” Patel said, adding this had a potential for “strong multiplier effects.”

One reason for the slowdown in investments is also due to the huge debt overhang for many large corporates, and banks too have been stretched due to rising bad loans.

The government and RBI are working in “close coordination” to resolve large stressed corporate borrowers and recapitalise public sector banks.

RBI had in June identified 12 accounts each having over Rs 5,000 crore in outstanding loans for immediate referral for resolution under the insolvency and bankruptcy code (IBC). These identified loans account for 25 per cent of total bad loans of banks.

N.S. Vishwanathan, deputy governor of RBI said dealing with NPAs was an ongoing issue and the central bank was in the process of taking next steps in addressing it.

Furthermore, the central bank has also raised concerns that banks have been slow in passing the previous rate cuts to its borrowers.

While most loans today are based on banks marginal cost of funds based lending rates, many customers are still on the older base rate formula. Viral Acharya, deputy governor of RBI noted that the base rate had remained relatively more “rigid” and there was a need to look at how it could be made more responsive to banks' cost of funds.

Radhika Rao, India economist at Singapore's DBS Bank, said the RBI rate cut was along the expectations. “Accompanying rhetoric is largely neutral, without giving away particular bias for the rate trajectory. The latter will allow the RBI to be non-committal on the future course of action, retaining the flexibility to react to the evolving inflation trajectory.”

While retail inflation is at its record low, several upside risks to inflation exist.

“Implementation of farm loan waivers by states may result in possible fiscal slippages and undermine the quality of public spending, entailing inflationary spillovers. Moreover, the timing of the states’ implementation of the salary and allowances award is critical – it is not factored into the baseline projection in view of lack of information on their plans,” RBI said, also noting that price pressures were building up in vegetables and animal proteins in the near months.

RBI sees inflation inching up to four per cent by the fourth quarter. Economists therefore expect it to keep rates on hold for a longer time.

“Headline inflation bottomed in June and we expect it to rise gradually to above the medium-term target of 4 per cent. Given our expectation of both growth and inflation rising over the next six to 12 months, we expect a prolonged pause from the RBI,” said Sonal Varma, chief India economist at Nomura Securities.

Others say the neutral stance leaves room for one more rate cut if inflation stays low, but it could hit the pause mode otherwise.

“We believe the neutral stance will give RBI the chance to reduce rates by another 25 bps if inflation trajectory remains benign (barring some spikes in vegetable prices) at less than four per cent mark for next 6-9 months. On the other hand, the neutral stance will enable RBI to remain on a long pause till the time inflation remains around 4 per cent mark,” said Kunal Shah, fund manager, debt, Kotak Mahindra Old Mutual Life Insurance.

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Topics : #RBI | #repo rate

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