RBI cuts interest rate

The Reserve Bank of India cut its benchmark interest rate by 25 basis points, a move likely to please Prime Minister Narendra Modi as he makes a final push for faster economic growth ahead of upcoming parliamentary elections. The Reserve Bank of India (RBI) is India's central banking institution, which...

The Reserve Bank of India cut its benchmark interest rate by 25 basis points, a move likely to please Prime Minister Narendra Modi as he makes a final push for faster economic growth ahead of upcoming parliamentary elections.

Background 

The Reserve Bank of India (RBI) is India's central banking institution, which controls the issuance and supply of the Indian rupee. Until the Monetary Policy Committee was established in 2016, it also controlled monetary policy in India. It commenced its operations on 1 April 1935 in accordance with the Reserve Bank of India Act, 1934. The original share capital was divided into shares of 100 each fully paid, which were initially owned entirely by private shareholders. Following India's independence on 15 August 1947, the RBI was nationalised on 1 January 1949.

The RBI plays an important part in the Development Strategy of the Government of India. It is a member bank of the Asian Clearing Union. The general superintendence and direction of the RBI is entrusted with the 21-member central board of directors led by the Governor.

The central bank was an independent apex monetary authority which regulates banks and provides important financial services like storing of foreign exchange reserves, control of inflation, monetary policy report till August 2016.

Analysis 

The RBI monetary policy committee cut its benchmark repo rates to 6.25 per cent, citing slowing economic growth and sharply lower inflation. The committee also changed its monetary policy stance to “neutral” from the previous outlook of “calibrated tightening,” suggesting there was room for future cuts. 

The monetary easing comes just three months after Urjit Patel, the former RBI governor, resigned amid widening differences with Mr. Modi’s administration over various economic and regulatory issues, including New Delhi’s perception that the RBI’s monetary policy was too tight. His resignation fuelled concern about central bank independence.

“The path of inflation has moved downwards significantly,” Shaktikanta Das, the new governor, said after the announcement on Thursday. “This has opened up space for policy action. The need is to stimulate private investment activity, and private consumption needs to be buttressed.” He added that “it is vital to act decisively and in a timely manner to address growth” given that the inflation target had been met. 

Over the past six years, India’s inflation rate has fallen from an annual average of about 10 per cent to 3.6 per cent in the last financial year, with headline inflation at 2.19 per cent in December. The pace of price increases is now below the target set in the RBI’s own inflation targeting framework of 4 per cent, with a band of 2 per cent plus or minus. 

Critics had previously accused the RBI of consistently overestimating India’s inflationary trajectory and being overcautious in cutting rates, a strategy they say has damped the country’s economic growth in recent years. 

In January 2019, leaders of the Confederation of Indian Industry met Mr. Das and appealed to him for a 50-point cut in interest rates and a cut in the bank’s capital reserve ratio to facilitate the flow of credit to industry and reduce its cost. The rate cut comes just days after India’s Central Statistical Office sharply raised its estimates of GDP growth for the past two years, implying that this year’s growth will be far slower than expected, with the economy’s prospects also hindered by mounting global headwinds. 

The RBI has also lowered its inflation projection, saying it would remain in a range of 3.2 to 3.4 per cent from April to October, then rise slightly to 3.9 per cent in the final quarter of 2019. Previously, the RBI had projected inflation of 3.8 to 4.2 per cent for April to October, with risks weighted to the upside. 

Assessment

Our assessment is that the latest interest rate cut is playing in the favour of BJP, who have promised to ramp up spending in their interim budget. We believe that the tight fiscal discipline of the government since 2014 has enabled the government to increase fiscal spending in the crucial three months before the election to maximise public visibility.  

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