RBI holds rates on inflation concerns
Reserve Bank of India (RBI) Governor Raghuram Rajan left the benchmark interest rate unchanged on Tuesday citing “upside” risks to its target of 5 per cent inflation by March 2017. The RBI kept the repo rate, the key rate at which the central bank lends money to commercial banks, at 6.5 per cent. Retail inflation in June was 5.77 per cent, well above the 5 per cent target set by the central bank. The central bank reiterated that it still maintains an “accommodative” stance. There are indications that prices of vegetables are edging down on the back of favourable monsoon rains, according to the central bank. The market anticipates at least one more rate reduction by March as a normal monsoon is expected to help bring down food prices, which had risen of late.
Abheek Barua, chief economist, HDFC Bank said that food prices would ease with a normal monsoon and decline in global food prices. “However, given the sticky services sector inflation and a likely boost in rural consumption, the fall in headline inflation is unlikely to be drastic enough to encourage more than one policy rate cut in FY17.”
Mr. Rajan expressed disappointment that banks had not done enough to reduce lending rates.
“Despite easy liquidity, banks have passed past rate cuts into lending rates only modestly,” he said. “Earlier, some bankers said that it was the lack of liquidity that was holding rates high, now I hear from some that it is fear of the FCNR(B) redemptions that is making them reluctant to cut rates. I have a suspicion that some new concern will crop up once the FCNR(B) redemptions are behind us,” Mr. Rajan said. Outflows of foreign currency deposits, which were raised in September 2013 to counter sharp depreciation of the rupee, were likely to be non-disruptive, Mr. Rajan added.
Bankers said a rate cut can happen if demand for loans picks up.
“We believe transmission of rates will happen gradually over the next few months as credit growth picks up pace,” said Arundhati Bhattacharya, Chairman, State Bank of India. RBI said it will review the present loan-pricing system and Marginal Cost of Funds based Lending Rate (MCLR), to make monetary transmission more effective.
The central bank is also implementing a liquidity framework indicating a move toward zero liquidity deficit. Commenting on the clean up of bank balance sheets he had initiated, Mr. Rajan said, “some banks have taken more steps than what was required. So the culture of cleaning seems to be well embedded as well as the culture of recovery of some of the loans.”
Industry expressed disappointment with the RBI decision.
“The economic situation is improving and a further cut in policy rate at this juncture would have been well timed,” said Harshavardhan Neotia, President, FICCI.
Mr. Rajan’s successor faces the challenges of integrating decision making with the Monetary Policy Committee, and ensuring a smooth transition process.
The 53-year-old former International Monetary Fund chief economist, who is set to step down on September 4, said there was a likelihood of the next rate decision being taken by a six-member Monetary Policy Committee “rather than an individual.”
“If that is the case, then there will be six people, sitting together and deciding what the path on interest rates will be. I think we should expect them to take an independent decision. I am sure, they will.” The Governor, under the new dispensation, will have a casting vote in case of a tie.