The Reserve Bank of India on Tuesday cut the repo rate—the rate at which
it lends to banks—and also cash reserve ratio by 25 basis points each.
While the stock market cheered the move even though the cut in repo rate
was on expected lines, bond market remanined lacklusture as it already
factored in. The central bank also lowered its inflation forecast for
the current fiscal to 6.8 percent from 7.5 percent. The simultaneous cut
in both repo and CRR has surprised many economists considering RBI's
cautious view in its macroeconomic report released yesterday.
A section of the market feels the central bank may have had little choice other than to cut the rate considering that the government has been doing its bit to address the fiscal deficit issue. So far, the RBI had been insisting that monetary easing would do little to stoke growth as long as the government did not manage its finances well. This time, the RBI has admitted to the government's efforts in its policy statement.
"Various measures undertaken by the Government since mid-September have significantly lifted market sentiment which, in due course, should spur investment," the RBI policy said.
At the same time, the RBI has cautioned that it will take time before the government policies actually revive growth in the economy.
Some feel the cut in policy could be also to lower borrowing costs for the government and facilitate the fiscal consolidation process by helping the government fix its balance sheet.
Many equity analysts have cautioned that banks will not be able to reduce their lending rates despite the rate cut, as deposit growth remains weak. Cutting lending rates would also necessitate cutting deposit rates, and the latter move could further alienate depositors.
And many bank chiefs had cautioned that unless there was a CRR cut as well, they would not be able to transmit the repo rate cut to their customers. So that could explain the CRR cut. But some economists point out that the CRR cut contradicts inflation management, as the RBI will now have to grapple with excess liquidity in the system. (The CRR cut will infuse around Rs 18,000 crore into the system).
By the RBI's own admission, inflation remains one of the key threats to its macroeconomic management going ahead. That is because demand pressures have begun to ease, but supply side constraints remain.
“In the absence of an effective supply response, inflationary pressures may return and persist with adverse implications for macroeconomic stability,” the RBI policy said, adding, “further moderation in domestic inflation going into 2013-14 is likely to be muted as the correction of under-pricing of administered items is still incomplete and food inflation remains elevated.”
But the biggest headache for the RBI remains the widening current account deficit. Because of the weakness in the global economy, it is unlikely that India's export growth will recover to the point where it can solve a good chunk of the CAD problem.
Foreign portfolio flows have helped bridge the CAD so far, but that is a risky strategy.
"Financing the CAD with increasingly risky and volatile flows increases the economy's vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability," the RBI policy said.
And while the market is hoping the RBI move today marks the beginning of a declining interest rate environment, the key to growth will be outside the monetary policy.
"The key to stimulating growth is a vigorous and sustained revival in investment. Achieving this will, however, depend on a number of factors such as bridging the infrastructure gaps, especially in power and transport, hastening approvals, removing procedural bottlenecks, and improving governance," the RBI policy said.
A section of the market feels the central bank may have had little choice other than to cut the rate considering that the government has been doing its bit to address the fiscal deficit issue. So far, the RBI had been insisting that monetary easing would do little to stoke growth as long as the government did not manage its finances well. This time, the RBI has admitted to the government's efforts in its policy statement.
"Various measures undertaken by the Government since mid-September have significantly lifted market sentiment which, in due course, should spur investment," the RBI policy said.
At the same time, the RBI has cautioned that it will take time before the government policies actually revive growth in the economy.
Some feel the cut in policy could be also to lower borrowing costs for the government and facilitate the fiscal consolidation process by helping the government fix its balance sheet.
Many equity analysts have cautioned that banks will not be able to reduce their lending rates despite the rate cut, as deposit growth remains weak. Cutting lending rates would also necessitate cutting deposit rates, and the latter move could further alienate depositors.
And many bank chiefs had cautioned that unless there was a CRR cut as well, they would not be able to transmit the repo rate cut to their customers. So that could explain the CRR cut. But some economists point out that the CRR cut contradicts inflation management, as the RBI will now have to grapple with excess liquidity in the system. (The CRR cut will infuse around Rs 18,000 crore into the system).
By the RBI's own admission, inflation remains one of the key threats to its macroeconomic management going ahead. That is because demand pressures have begun to ease, but supply side constraints remain.
“In the absence of an effective supply response, inflationary pressures may return and persist with adverse implications for macroeconomic stability,” the RBI policy said, adding, “further moderation in domestic inflation going into 2013-14 is likely to be muted as the correction of under-pricing of administered items is still incomplete and food inflation remains elevated.”
But the biggest headache for the RBI remains the widening current account deficit. Because of the weakness in the global economy, it is unlikely that India's export growth will recover to the point where it can solve a good chunk of the CAD problem.
Foreign portfolio flows have helped bridge the CAD so far, but that is a risky strategy.
"Financing the CAD with increasingly risky and volatile flows increases the economy's vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability," the RBI policy said.
And while the market is hoping the RBI move today marks the beginning of a declining interest rate environment, the key to growth will be outside the monetary policy.
"The key to stimulating growth is a vigorous and sustained revival in investment. Achieving this will, however, depend on a number of factors such as bridging the infrastructure gaps, especially in power and transport, hastening approvals, removing procedural bottlenecks, and improving governance," the RBI policy said.