RBI Cuts Repo Rate By 25 BPS, Further Easing Appears Limited

The Reserve Bank of India (RBI) governor Raghuram Rajan cut interest rates for a third time this year on Tuesday, 2nd June, 2015 taking advantage of subdued inflation to give more support to an economy. Mr. Rajan’s move widely disappointed markets which fell by 660.6 points to close at a three week low of 27,188, as many market players were hoping for a 50bps cut. 

However, the RBI cut the Repo rate by 25 bps to lower it to 7.25%. This means that the RBI has cut interest rates by 75 bps since Jan 2015. Repo rate, the rate at which RBI lends to commercial banks in the event of any shortfall of funds, is the tool used by RBI to manage inflation in the economy.

With this rate cut; Governor Rajan is back where he began. In September 2013; when he took over as the governor of RBI; the Repo rate was at 7.25%. He hiked the repo rate to 8% by February 2014 to signal the RBIs inflation fighting credentials and its move to a CPI inflation targeting driven monetary policy framework. As CPI inflation fell more than anticipated in the last year he has front-loaded the rate cuts to bring the Repo rate back to 7.25%. It is expected that RBI is likely to go on a long pause till at least the first quarter of 2016.

Markets have clearly not liked the outlook. So despite a rate cut; given that further easing appears limited; both the Equity and Bond markets sold off.

The RBI has shifted its growth and inflation targets. The RBI now expects inflation to be around 6% due to the expectation of a poor monsoon; up from its forecast last time of 5.8%. At the same time it has revised the GDP growth downwards as the government report showed that the growth for FY 15 was lower than initially expected.

As pointed out by the Governor, it is common for banks to promptly lower their deposit rates and keep lending rates unchanged for long. This time, following RBI’s rate cut few banks have already cut EMI for loans. Deposits rates would come down too. However with the next rate cut far away, EMIs may stay there for a while after the present rate cut benefit is passed on.