Rajan holds rate; banks bow to RBI pressure

Raghuram Rajan is known for his ability to surprise markets. He remained true to form in the first bi-monthly monetary policy review in the new financial year. While the Reserve Bank of India Governor opted for a status-quo in the repo rate and the cash reserve ratio (CRR) at 7.5 per cent and 4 per cent, respectively which made the policy a non-event, the sting in the tail came from his unusually strong stand on the reluctance of banks to cut lending rates despite two out-of-policy repo rate cuts of 25 basis points each.

The words he chose were strong, marking his impatience that only a couple of banks have lowered lending rates after the earlier repo rate cuts, raising concerns over the transmission of monetary policy to the broader economy.

He dismissed bankers’ claims that the cost of funds remained too high. “Banks are sitting on money. Their marginal cost of funds has fallen. The notion that it hasn’t fallen is nonsense,” Rajan said.

RBI said in a statement after its policy review that it would maintain an “accommodative stance”, but also cited risks, raising some uncertainty about when the central bank would cut interest rates next.

That the absence of monetary transmission is on top of Rajan’s must-do list is clear from the preconditions for further rate cuts. “Going forward, the accommodative stance of monetary policy will be maintained, but monetary policy actions will be conditioned by incoming data. But first, RBI will await the transmission by banks of its front-loaded rate reductions in January and February into their lending rates,” the statement said. Later, Rajan exuded confidence that the pass-through would happen.

Bankers seem to have got the message and said at a post-policy press conference that the lending rate trajectory was down. “Rates will definitely come down,” said State Bank of India Chairman Arundhuti Bhattacharya, though she was non-committal on when and by how much. HDFC Bank MD & CEO Aditya Puri said lending rates would  come down “between April and June”, while his counterpart at ICICI Bank, Chanda Kochhar, said she saw an “easing rate scenario”. None of the bankers, however, were willing to comment about the timing, though they said further deposit rate reduction could be on the cards.

The bankers, however, weren’t amused by Rajan’s statement that in order to improve the efficiency of monetary policy transmission, RBI “will encourage banks to move in a time-bound manner to marginal-cost-of-funds-based determination of their base rate”. While Bhattacharya said this was something that “can’t happen tomorrow and requires a long transition period”, Puri said the process had to be “carefully calibrated”, indicating that RBI and banks were not on the same page on this issue.

Though the central bank said there could be scope for further rate cut in future, expectations were subdued. Experts said any scope of further easing was limited as December-end retail inflation was seen at 5.8 per cent while RBI wanted the real interest rate to be kept between 1.5-2 per cent. While some experts only see a 25 bps cut in 2015, the more optimists see a 50 bps cut. “If I choose to be hawkish then I will take2 per cent as real rate while I will settle for 1.5per cent if I am dovish,” Rajan said.

Industry was disappointed. Ajay S Shriram, president of the Confederation of Indian Industries, said RBI had enough space to cut rates even while delivering on the inflation mandate. By not doing so, the central bank may have missed an opportunity to offer a “mood elevator” and augment demand. Stock markets shrugged off the policy review and a marginal recovery in rate sensitive shares in late trades helped the indices recoup intra-day losses to finally end flat. The 30-share Sensex ended up 12 points at 28,517 while the 50-share Nifty ended nearly unchanged at 8,660.

Rajan did not expect RBI policy to be blown off course by the prospect of the Federal Reserve raising US rates. Whereas higher US interest rates are expected to lead to capital outflows from some emerging market economies, the rupee has remained firm against other currencies thanks to strong inflows. “At this point… we feel we are adequately buffered. That is not going to be the key factor in determining our monetary policy.

The central bank sounded cautiously optimistic on the growth outlook. It expects lower inflation, higher profit margins and government efforts to kick start investments to support a gradual growth recovery. The RBI projected FY16 real GDP growth at 7.8 per cent year-on-year, up from 7.5 per cent in FY15. It expects consumer price index inflation to remain below 6 per cent in FY16, falling to around 4 per cent by August 2015 before firming up to 5.8 per cent by March 2016. RBI re-iterated its commitment to lowering CPI inflation to 4 per cent by March 2018.