|WHAT YOU WANTED TO KNOW ABOUT THE
MONETARY POLICY BUT WERE TOO BORED TO ASK
|FOOLED YA! RBI governor Raghuram Rajan smiles during the news conference at the RBI headquarters in Mumbai on Friday. “Of course, we are anti-inflation... of course, our intent is to signal a stance against inflation,” Rajan said. (AFP picture)
Mumbai, Sept. 20: RBI governor Raghuram Rajan stunned the Street and Big Business today with a rate hike that overshadowed his message to use a US-gifted breather to create a “bullet-proof national balance sheet and growth agenda”.
Rajan raised the repo rate by 25 basis points to 7.50 per cent, capping a week of Big Surprises that started with the US Federal Reserve holding off on the anticipated tapering of its cheap money policy on Wednesday.
The Fed’s decision had sparked expectations that the Rajan would refrain from tinkering with the rates and would only roll back some of the money-draining measures that the RBI had announced in July to put a lid on the excessive volatility in the rupee –US dollar exchange rate.
Rajan’s surprise decision to raise the repo rate – the first time that the policy rate has risen since October 25, 2011 – signals the end of the 17-month easing phase that started in mid-April last year during which rates were cut by 125 basis points.
The RBI governor said the rate hike was designed to create a “nominal anchor” for inflation that “will allow us to preserve the internal value of the rupee”. In the past, the RBI has indicated that its comfort level was an inflation rate of 5 per cent but Rajan didn’t spell out the figure that he had in mind.
“When the repo rate becomes the effective policy rate, it should be consistent with inflationary conditions in the economy,” Rajan said, justifying why he had raised the sole rate-signalling device in the central bank’s armoury.
The rate increase sent the markets into a tailspin: the sensex plunged by almost 600 points at one stage before clawing back some of the losses. It closed at 20,263.71, down 382.93 points or 1.85 per cent lower than Thursday’s close.
The rupee was roiled as well, falling 46 paise to close at 62.23 against the dollar.
Lenders like the State Bank of India (SBI) said they would raise lending rates again as they intend to pass on the burden of higher borrowing costs resulting from the repo rate hike to their customers.
Rajan was hoping that he would be able to head off that possibility because he had cut the rate on the marginal standing facility (MSF) — a special borrowing window that the central bank created in May 2011 to help banks meet emergency cash needs — by 75 basis points to 9.50 per cent.
Data drawn from the RBI show that the banks borrowed Rs 40,036 crore from the repo window and twice that amount — Rs 81,084 crore — from the MSF window on Thursday, which may have lent some credence to Rajan’s belief.
Historically, banks have tended to raise lending rates whenever the repo has been hiked and extremely reluctant to cut when the repo has been trimmed.
Between April 2012 and May this year, the RBI cut the repo by 125 basis points while banks have cut their lending rates by about 40 basis points, prompting finance minister P. Chidambaram to remark recently that commercial banks still had some headroom to cut rates.
“We will now have to live with elevated interest rates in the system for some time to come,” said Samiran Chakrabarty, chief economist at Standard Chartered Bank.
Indranil Pan, chief economist at Kotak Mahindra Bank added: “Going forward, we expect the RBI to stay hawkish on inflation and raise repo rates further by 50 basis points by the end of calendar year 2013.”
The logic behind the repo rate hike — which was lost on the skittish markets — is that it will help beat down inflation that is currently riding at 6.1 per cent.
But it fanned fears that India’s economic growth had been sacrificed once again at the altar of monetary expedience of reining in inflation — an objective that Governor Rajan has unequivocally underlined as the key mandate of the RBI.
The nuancing of Rajan’s maiden monetary policy statement may have been different but the basic tonality was the same as his predecessor’s, Duvvuri Subbarao, who had fought off pressure from finance minister P. Chidambaram last October to cut rates to revive a faltering economy.
At a post-policy press conference, Rajan took pains to explain that his maiden monetary policy would not hurt economic growth.
“We have to be careful about associating the repo rate hike to growth implications. Sometimes, the knowledge that inflation will be lower can actually enhance growth prospects rather than reduce them. I don’t think you want to immediately conclude that this (policy) is negative for growth. You must also remember that it is clubbed with a substantial reduction in the MSF rate, which is growth positive. I think that analysts should weigh the measures together rather than see it as a unilateral issue.”
Rajan also said that the US Federal Reserve’s plan to postpone the tapering of its quantitative easing program under which it buys bonds worth $85 billion a month had given central banks around the world some breathing space.
“We must use this time to create a bullet-proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike.”
“We will be in a much better position (to deal with the Fed tapering), much stronger position and we won't have to worry that much,” he added.
OH BABUA, YEH RATE-WAYTE KYA HAI?
What is the
It is the rate at which commercial banks borrow funds from the RBI. The amount that banks can borrow from this window
is capped at 0.5 per cent
of their total deposits. Since May 2012, the repo has become the sole signalling device for interest rates. Other rates move in tandem with the repo.
The repo was raised on Friday by 0.25 percentage points to 7.5 per cent.
So, the reverse repo — the rate that determines how much money banks earn on the deposits they park with the RBI — rose
by the same margin
to 6.5%. Since 2011,
the reverse repo has always been kept 100
basis points below
Why do the interest rates on my home
and car loans go up
when the repo rate
The repo is a short-term interest rate. It covers banks’ borrowings from
the RBI for a tenure of
one to three days. Banks use this form of borrowing to meet immediate
say, a sudden demand
for loans from consumers. A rise in the repo rate
leads to an increase in borrowing cost for banks, which usually choose to pass it on to their borrowers in the form of higher lending rates
How does the repo
rate help control inflation?
Higher interest rates lower overall demand for goods and services and push down prices
Does this mean prices will come down?
A lower inflation rate does not mean prices must go down. A lower inflation means prices will not rise at a higher pace. A myriad factors play on prices — wage hikes, the exchange rate, import costs, global oil prices, etc
What is Raghuram Rajan trying to do?
Rajan has indicated that tackling inflation is the principal mandate of the RBI — iterating what he said in 2007 when he prepared a report on financial sector reforms. By raising the repo rate, he is proposing to use the sole monetary instrument — some call it a blunt instrument — to tackle inflation
What would he have done
if he had wanted to focus
This is an area of great debate. Both Rajan and his predecessor, D. Subbarao, have contended that inflation is the sole remit of the RBI. Subbarao believed it was not possible to use monetary policy instruments to ignite growth. He believed that growth could only come from fiscal and administrative reforms initiated by the Centre.
Rajan hasn’t gone so far. But his policy statement says: “As infrastructure investments are expedited, and as projects cleared by the Cabinet Committee on Investment come on stream, growth could pick up in the second half of the year.”
P. Chidambaram has always believed that if the RBI cuts rates, the economy will grow.
It led to a prickly relationship with Subbarao. On Friday,
a studied silence
How could a cut in the repo rate have helped growth?
Chidambaram and India Inc believe that if borrowing costs go down, the demand for funds will increase. Ergo, investments in projects will rise. Once stalled projects get off the ground and new capacity is created, economic growth will automatically ensue
Are projects on hold because of a paucity
Projects are stalled because of a reluctance to borrow at high costs. Other problems: difficulty in acquiring land, environmental clearances and raw material linkages. There is no liquidity constraint for genuine investment needs
What else has
the RBI done?
The interest rate on the marginal standing facility (MSF), a window for banks to borrow from the RBI in an emergency, has been trimmed. The RBI has also reduced the minimum daily maintenance of the credit reserve ratio (CRR) — the proportion of deposits that must be kept with the RBI
What are the implications of the two decisions?
They will reduce the cost of funds for banks. But lenders like SBI are already talking of raising lending
Do depositors stand to gain?
Yes, there could be a deposit rate hike.