The Virtue of Patience: RBI and the repo-rate

On 29th September, all eyes will be on the Reserve Bank of India as it announces its monetary policy. Amidst wild speculation in the market, Raghuram Rajan, the 23rd Governor of the Reserve Bank of India, again finds himself under the spotlight. Mr Rajan has a reputation for surprising the nation with his decisions. Some experts do believe a shock therapy works best in monetary policy. This is the reason why despite all signs pointing to a reduction in repo-rates, there is skepticism on what the Fourth Bi-monthly Policy Statement for the year 2015-16 will reveal.

When Mr Rajan cut interest rates for the third time this year in June, there was marked disappointment in the market and the analysts on the 25 basis point drop to 7.25%. It was heralded as an excessively conservative measure as most felt that a 50 basis point cut was warranted owing to easing in inflation and subdued investment and credit growth. However, the possible factors considered in opting for a rather limited drop were the below normal predictions for the monsoon, the then present volatility in the crude prices and the unpredictability in the external markets of USA and China. These prompted the RBI to adopt a conservative strategy to wait and watch as the scenario unfolded, especially on the front of monsoons and the market reaction to the central government initiatives. An efficient food management system and positive market outlook was required to counter the negative effects of the inadequate rainfall in some areas of the country. Besides, managing liquidity in the economy was essential to stem the eventual hike in inflation.
Mr Raghuram Rajan, Governor of the Reserve Bank of India

It has been three months since and the next monetary policy statement is on its way. The US Federal Reserve’s decision to keep the interest rates unchanged, gives RBI the adequate time and width to take chances. Several government policy makers and business leaders have advocated a cut in interest rates to boost economic growth, but the central bank’s priority as always is to ensure a sustainable reduction in inflation. Having successfully accomplished that over the last months, RBI would like to continue the trend while simultaneously fueling the sluggish economy. Consumer inflation sank to a record low of 3.66% in August, over two percentage points lower than the central bank’s January 2016 target, piggybacking a steep fall in global commodity and oil prices. Meanwhile, analysts have voiced with considerable conviction that although the US Federal Reserve sat firm on its rates due to the turmoil caused by the Chinese currency devaluation, the US central bank is expected to raise rates for the first time in nearly a decade in December. Undoubtedly, the window of opportunity for the much awaited rate cut is quite narrow and therefore, a 25 basis point cut to 7.00% seems the expected fallout. 

However, there are many, especially in the industry and government, who are rooting for a higher interest rate cut of 50 basis points, arguing that a timely confluence of factors dictate for such a measure. They contend that India needs to turn focus on growth now, lest the wait for revival in growth gets longer and foreign investors get impatient and leave. This opinion may not be agreed upon by the central bank as many factors continue to look dire. The rainfall deficiency can hurt the Rabi (winter) crop, negating some of the gains from lower fuel prices, keeping inflation on the higher side. Another factor that Mr Rajan has mentioned it a generous drop in interest rates may discourage the flow of foreign capital into India, which despite its fluctuations remains high and continues to see growth. Moreover, the Federal Reserve can only delay, but must eventually must go ahead with its rate hike. Also, Raghuram Rajan has repeatedly warned against quick-fixes and has stuck to his path based on economic fundamentals despite being under enormous pressure in the past. 

In spite of the repo-rate coming down 75 basis points since January, a moderate growth in the industrial and manufacturing sector may force a fourth reduction by 25 basis points in the calendar year. To know what steps are finally taken and how it affects the Indian economy, we’ll have to wait and watch.

P.S.: This article was written before the Fourth Bi-monthly Policy Statement for the year 2015-16. In the statement, Mr Raghuram Rajan announced a surprise 50 basis-points cut, leaving the current repo-rate at 6.75%.

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