In a major election time boost for the government, the RBI has eased repo rate by 25 basis points, meaning more funds & liquidity in the market.
Modi government has finally prevailed on the RBI. In a move that is supposed to have broad implications for the markets, essentially banking, real estate & housing sectors, the RBI has cut lending rates to banks down to 6.25% from 6.5%. The finance ministry has fought a sustained battle internally with the RBI that resulted in two of its celebrated Governors bow out of the office. While Raghuram Rajan was tipped to be given an extension that didn’t happen, his successor Urjit Patel left unceremoniously before completing his full tenure. With a more pliable Shaktikanta Das at the helm, the government is hoping to cut loose on the tight monetary controls by the governing institution. Incidentally the current Governor had presided over one of the worst the worst economic decisions in recent history by way of Demonetisation. He seems to have immediately paid back the favour to his political bosses by announcing the rate cut & one should expect more Pro-Government measures to step in days to follow as amplified by none other than the Economic affairs secretary D C Garg.
Even when we were to argue that the reduction in interest rates for loans was a justified call by the regulatory bank, whether or not this measure goes beyond inducing a symptomatic relief, remains to be seen
In about 18 months, this is the first cut in Repo rates that the RBI has announced for the commercial banks. It has also changed its stance from ‘calibrated tightening’ to ‘neutral’, an indication that it shall assist the government in easing the liquidity crunch, which had become a bone of contention between the government and the central bank of late. Welcoming the decision Mr. Garg said that the monetary policy affects the government borrowing rates, bond rates and plays into other implications like investments made by public and private sectors. Investment decisions are to some extent affected by the interest rates prevalent in the economy. Logically in a lower interest rate situation the investment should go up. However, there are many other factors and it is not one exclusive factor,” he said.
The Government is expecting an early transfer of the interim dividend from the RBI which was withheld earlier due to various reasons, one being the amount that could be kept by the RBI as its guarantee against defaults by borrowers.
As per the budget estimate for 2018-19, the government had assessed it may get Rs 68,000 crore from the RBI as its dividend of which it has already received Rs 40,000 crore. According to a Reuter’s poll of economists, The Reserve Bank of India (RBI) is expected to cut interest rates again next quarter, with a slim majority forecasting policy easing to occur before the general election in May. A Reuter’s snap poll taken immediately after the current policy review showed the central bank will make the same move next quarter. That would take the RBI’s repo rate to 6.00 percent; it’s lowest since the middle of last year.
“Governor Das’ remark that ‘there is room to cut’ suggests this is not a one and done easing,” said Radhika Rao, economist at DBS Bank. “We revise our call to include a 25 basis points cut in April, before rates stabilise.” It is a given that such easing of tight controls over monetary policy, would be used by the incumbent government to lift its sagging image & boost the growth just ahead of the elections & after. This is welcome news for Prime Minister Narendra Modi’s government, which wants to lift lending after delivering a populist interim budget in an effort to woo over 900 million eligible voters.
Since there was a disparity between core inflation, which is running closer to 6 percent, and the headline figure, the RBI governor has effected this cut in interest rates in response to a temporary fall in the headline rate, which at best seems quite short-sighted,” said Gareth Leather, senior Asia economist at Capital Economics. “He is under a lot of political pressure to cut monetary policy rates and that is the reason he has done it.” While some economists did argue that the key driver of expectations for a further rate cut ahead of the election is pressure from the government, about 85 percent of respondents who answered a separate question said the one just delivered was not a mistake. “The rate cut was due, but the timing was a surprise. They front-loaded the rate cut, which was the surprise element. With downside risks to growth, and inflation well within the comfort zone of the RBI, and real interest rates high, a rate cut was expected,” said Upasna Bhardwaj, senior economist at Kotak Mahindra Bank.
With a follow up cut expected next quarter, the RBI Monetary Policy Committee (MPC) forecast was to keep interest rates on hold at least until the fiscal year starting April 2020. That suggests it is not the start of an easing cycle, something over 55 percent of economists concurred with in response to an additional question. “A decisive change in tone, with even the perpetual (MPC) hawk, Dr. Michael Debabrata Patra, joining the rate cut camp, gives further credence to our view that one more cut is on its way,” said Madhavi Arora, economist at Edelweiss Securities.”However, further easing beyond April will see the bar set a tad higher.”
In the wake of a fierce trade war between USA & China, major central banks have also sharply reversed policy to factor in the rising growth risks, with pressure on businesses. That has prompted the U.S. Federal Reserve, the European Central Bank and the Reserve Bank of Australia, to switch to a dovish stance. Referring to that policy shift by global central banks, Vishnu Varathan, head of economics and strategy for Asia at Mizuho Bank said: “The RBI may prove to be famously prescient on this one and may well be ahead of the curve. It is not a curve I want to see.””But for me with the evidence in hand, it looks more like a gambit than a calculated policy decision.”