RBI does the unexpected again; reduces repo rate by 50 bps

29 Sep 2015 Evaluate

In a most surprising move the Reserve Bank of India (RBI) reduced the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points (bps) from 7.25 per cent to 6.75 per cent. The apex bank said that since last review, the bulk of its conditions for further accommodation have been met and the January 2016 target of 6 per cent inflation is likely to be achieved. Furthermore, it said that 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. RBI governor termed the decision a front loading action after the Federal Reserve had postponed policy normalization.

In its policy stance at the fourth Bi-monthly Monetary Policy Statement, 2015-16, RBI decided to:

•reduce the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points from 7.25 per cent to 6.75 per cent with immediate effect; consequently, the reverse repo rate under the LAF stands adjusted to 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 7.75 per cent.

•keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liability (NDTL);

•continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity under 14-day term repos as well as longer term repos of up to 0.75 per cent of NDTL of the banking system through auctions; and

•continue with daily variable rate repos and reverse repos to smooth liquidity.

In its policy review RBI noted that since the third bi-monthly statement of August 2015, global growth has moderated, especially in emerging market economies (EMEs), global trade has deteriorated further and downside risks to growth have increased.

Regarding inflation RBI said that the disinflation has been broad-based and inflation excluding food and fuel has also come off its recent peak in June. Looking forward, inflation is likely to go up from September for a few months as favourable base effects reverse. The outlook for food inflation could improve if the increase in sown area translates into higher production.

RBI also pointed that though markets have transmitted the Reserve Bank’s past policy actions via commercial paper and corporate bonds, but banks have done so only to a limited extent. The median base lending rates of banks have fallen by only about 30 basis points despite extremely easy liquidity conditions. This is a fraction of the 75 basis points of the policy rate reduction during January-June, even after a passage of eight months since the first rate action by the Reserve Bank. It further stated that while the Reserve Bank’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed.

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