India industry welcomes interest rate cut

Posted on October 4, 2016

India’s central bank, led by its new chief Urjit Patel, took advantage of lower inflation to cut its key interest rate by 25 basis points. Tuesday’s decision was welcomed by industry groups, which had been clamouring for lower borrowing costs.

The policy rate reduction — from 6.5 per cent to 6.25 per cent — marks the start of a new era for the Reserve Bank of India, whose interest rate decisions will now be made by a six-member Monetary Policy Committee rather than exclusively by the governor. 

Mr Patel, a former RBI deputy governor promoted after the departure of his high-profile predecessor Raghuram Rajan, said the first two-day meeting of the MPC was characterised by discussions that were “frank, often intense but always friendly”. 

In its unanimous resolution, the committee said the recent reduction in consumer price inflation — on the back of a bountiful monsoon season and government policies to cool food prices — had “opened up space for policy action”. The cut is the first since April, when interest rates hit a five-year low and Mr Rajan began a 125-basis-point easing cycle. 

Industry groups, which believe Mr Rajan should have lowered interest rates sooner and more aggressively, expressed hope that the rate cut would revive stagnant investment. 

“We can very clearly see that in the growth-inflation trade-off, the RBI is favourably inclined towards promoting growth in the economy,” said Chandrajit Banerjee, director-general of the Confederation of Indian Industry. 

However, the MPC sounded a cautionary note, warning of the potential for “cost push pressures” in the coming months as a result of the recent 23 per cent increase in salaries, allowances and pensions for nearly 10m current and former civil servants. 

“The fuller play of these factors will need vigilance to prevent generalised cost spirals from taking root,” the statement warned. 

At a brief press conference, Mr Patel said that government reforms, including improved food stock management and investment in railways, could help ease supply constraints and reduce inflationary pressure over the next two years. 

But some analysts suggested the RBI had taken “a gamble” by lowering rates too early in the agricultural cycle before it was clear that food prices were on a sustainable downward trajectory. 

“In the recent past, food inflation has surprised on the upside more than on the downside,” said Sunil Sinha, chief economist at India Ratings, an arm of Fitch Ratings. “A better approach would have been to wait for another two months. Then, if things turn out your way, go for a rate cut. Here, they have chosen to front load it in the hope that things will turn out as they are expecting.” 

In 2015 the RBI adopted a formal inflation-targeting monetary policy framework, with a consumer price inflation target of 4 per cent, within a band of 2 percentage points up or down. 

In August, India’s benchmark consumer prices index rose 5 per cent year on year in August, a downward moderation from its 6 per cent year-on-year increase in July. The MPC resolution said that headline inflation was moving to a “central trajectory of 5 per cent by March 2017”, though it acknowledged the potential of upside risk. 

Mr Sinha said Tuesday’s rate cut would hit savers, whose real rate of interest is being reduced to 1.25 per cent, down from the 1.5 to 2 per cent target that Mr Rajan had consistently tried to maintain.

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