Despite the risk, Rajan lowers rate

Despite the risk to falling inflation, RBI governor Raghuram Rajan lowered the repo rate by a quarter per cent to 7.25 per cent in deference to low domestic capacity utilisation, mixed indicators of recovery and subdued investment and credit growth. He hoped the banks would pass this on to borrowers and noted that so far they have only cut fixed deposit rates by one per cent. Those with home loans and personal loans will have to wait a little longer for their EMIs to come down significantly. The RBI has since January this year cut its policy rate by 0.75 per cent and banks have passed on barely 30 per cent of this. Dr Rajan also promised that by August end he would be giving at least one licence for a payment bank or a small bank.

 

Asked at the post-policy press conference whether he cut interest rates despite inflationary risks just to please the government, Dr Rajan said jokingly, “If I cut interest rates, I am accused of trying to please the government. And if I don’t cut interest rates, I am accused of trying to fight the government!” Going forward there would be room for more action if the monsoon is better than expected as it would be data-contingent.

 

If the monsoon is much below normal, as the latest IMD forecasts indicate, inflation would depend on how effectively the government handles the supply situation. Government action is important, as seen in 2002-03 when the rains were weak but inflation was limited. However, Dr Rajan’s emphasis on the responsibility of government to handle the supply side to curb inflation spooked the stock markets, which interpreted it as a hawkish outlook. Bears hammered the markets and the Sensex collapsed 660 points whilst the Nifty plunged 197 points.

 

The RBI governor said the government was trying to clear the bottlenecks and pathways to grow and that they would work together to further growth.

 

The RBI governor believes inflation could start rising after August, when the base effect ends, and therefore revised inflation upwards to six per cent by January 2016. This could also be exacerbated by the increase in the service tax rate, a below-normal monsoon, global crude prices which have been firming up, and volatility in the global environment.

 

The RBI also revised growth slightly downwards, to 7.2 per cent from the 7.8 per cent announced in April. Dr Rajan had a wonderful suggestion for the government with regard to the minimum support price, which today leads to some crops being grown in abundance to the neglect of others. He suggested that MSP should be extended to a larger number of crops, which the farmers too had been demanding, and over the whole of India. Today it is mostly restricted to Punjab, Haryana and parts of Uttar Pradesh, for rice and wheat.