RBI’s surprise rate cut

The ability to surprise the markets is an important trait of central banking and Reserve Bank of India (RBI) Governor Raghuram Rajan displayed that when he cut interest rates by 0.25 percentage points early on Thursday. Given the favourable economic data releases of the last one week on inflation and industrial output, a rate cut was expected, if at all, in the next bimonthly monetary policy of the RBI scheduled for February 3, but Dr. Rajan chose to act ahead of that. In a way, the Governor was only keeping a promise he had made at the time of the last policy announcement in December, that monetary policy stance could change outside of the policy review cycle if circumstances justified the same. The rate cut, given its quantum, may be largely symbolic and not lead to a significant drop in borrowing costs for individuals and companies, but it signals an important shift in the monetary policy position of the central bank. The signal is clear: the easing cycle has begun and more, deeper cuts are likely if inflation and the Centre’s fiscal deficit remain under control in the near future. Little wonder then that the stock market reacted with such exuberance to the first rate cut in 20 months and also the maiden one of Dr. Rajan’s tenure — the benchmark S&P BSE Sensex shot up by 729 points or 2.66 per cent as hopes soared of a revival in investment and consumption.

Having delivered on a long-standing demand of India Inc, the Governor has now shifted the onus on to the Centre to ensure that the rate easing cycle is sustained. He left little doubt in anybody’s mind, clearly pointing out that further easing is contingent on the continuation of the disinflationary process in the economy. Also critical will be the success of the government in meeting its stiff fiscal deficit target of 4.1 per cent this fiscal. In addition, Dr. Rajan has also pointed, correctly, to the need for continuing efforts to overcome supply constraints and ensure availability of inputs such as power, land, minerals and infrastructure. With tax revenues growing at well below the expected rate, the telecom spectrum auction coming up in February and the disinvestment programmes in public sector companies assume crucial importance. The Budget for 2015-16, which will be presented in February, is also important as it will reveal the fiscal consolidation plans of the government. As for corporate India, the rate cut may appear small and might not translate into significantly cheaper funds as yet. But it should be taken for what it is: a cue that the central bank is now comfortable with the macro economic indicators and has started the rate easing process. It is now up to the corporate sector to get back to the drawing board and start investing afresh.

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