A Front-Loaded 50-Basis Point Interest Rate Cut in India

September 29, 2015

The Reserve Bank of India’s repo and reserve repo rates were each reduced by 50 basis points to 6.75% and 5.75%.  The size of the cut was twice as much as expected and follows three 25-basis point reductions during the first half of calendar 2015.  A statement from RBI Governor Raghuram Rajan characterizes policy as “accommodative” but calls today’s action “front-loaded.”  That implies a pre-emptive move and that the central bank will not cut rates again so soon as they would have done had only another 25-bp cut been undertaken. 

Investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow. Therefore, the Reserve Bank has front-loaded policy action by a reduction in the policy rate by 50 basis points. Given our year-ahead projections of inflation, this ensures one year expected Treasury bill real interest rates of about 1.5-2.0 per cent, which are appropriate for this stage of the recovery.

The statement observes that the long-held goal of 6% inflation by January 2016 will likely be achieved and that slower global growth and cheaper commodity costs will promote a further deceleration to around 5% by mid-2017.  New inflation forecasts are thus somewhat lower than the previous forecast.  The statement prioritizes monetary policy as primarily responsible for lowering inflation and fiscal and other government policies as better positioned for raising India’s potential growth rate.  Fiscal policy changes are complimented in the statement, and the monetary authorities pledge to run a stance that doesn’t undermine government efforts but, by the same token, not jeopardizing the mandates of inflation containment. 

The 4.0% reserve requirement was not changed, but a cut in early 2016 of the statuatory liquidity ratio to 21.5% from 22% was decided.  Prior to the 25-bp repo rate cuts in January, March and June of this year, an easing cycle that mirrors the cumulative 125-basis point size of the current one was undertaken in 2012-2013 vias cuts of 50 bps in April 2012 and then three drops of 25 bps each in January, March and May of 2013.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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