I do what I do” never has been a more prosaic and yet effective statement. And yet that is what RBI Governor Raghuram Rajan said today at the conference to announce his rate cuts. “My name is Raghuram Rajan, and I do what I do,” was the RBI Governor’s response to comments that he was being Santa Claus in cutting interest rate by more than expected. Amid government and industry pressure, Rajan has officially cut interest rates by 0.50 percent, double of what was broadly anticipated by industry analysts and the biggest in more than three years. The cut brought down repo rate to 6.75 percent, the lowest in four-and-half-years. For the uninitiated here is why the repo rate is important. The repo rate is the rate at which the central bank of a country (Reserve Bank of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.
In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation. The central bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rate <g data-gr-id="33">form</g> a part of the liquidity adjustment facility. According to a noted Wall Street analyst, an easing move was widely expected by markets, with 11 out of 13 economists polled by a noted market magazine last week predicting the RBI would cut rates. However, analysts had forecast a more modest cut of 0.25 percentage point. Eight of the economists predicted that Rajan would cut rates by another 0.25 percentage point during this fiscal year, which ends in March. Rajan noted in the policy statement that inflation hit a nine-month low in August and that despite the monsoon shortfall and the uneven distribution of seasonal rains, food inflation pressures have been contained.
Some of the reasons that might have prompted Raghuram Rajan to cut rates may have been- There has been a moderation in inflationary pressure. The consumer price index (CPI) or the retail inflation has been on a decline. In August, it touched a 10th month low of 3.66 percent, which is well below the targeted level of 6 percent. Regarding the monsoon, there is not all bad on the monsoon front. According to Indian Meteorological Department (IMD), the monsoon deficiency has been reducing though the full impact would be visible only after October month this year. The US Fed rate action was much awaited as any hike in the interest rate would be resulted in some short-term panic in terms of an outflow of dollars from emerging markets like India. The dollar outflows weaken the currency, thereby raising the threat of imported inflation. But Fed once again has deferred the decision to end of this year. This has brightened the chances of a rate cut now.
Interest rate transmission: Governor Rajan has been concerned about delay in monetary transmission as 75 basis points reduction has only resulted in a 25-30 basis points reduction in banks’ base rate, which is the minimum lending rate. This shouldn’t come in the way before cutting interest rates as RBI is now devising other ways for faster transmission to retail as well as corporate borrowers.