India: Reserve Bank cuts interest rates unexpectedly
March 4, 2015
In an unscheduled meeting on 4 March, the Reserve Bank of India (RBI) decided to reduce the repurchase rate by 25 basis points, from 7.75% to 7.50%. The move was unexpected by market analysts and came after the Bank’s decision to hold the repurchase rate at its 3 February meeting. In order to maintain the corridor at which monetary policy rates move, the Bank also decided to cut the marginal standing facility rate (Bank rate) from 8.75% to 8.50% and the reverse repurchase rate from 6.75% to 6.50%.
Commenting on the decision, the Central Bank recognized that recent economic data has confirmed disinflationary pressures. Further, the new consumer price index has showed that inflationary pressures are evolving as anticipated by the Reserve Bank last year, although at a faster pace than predicted. The monetary authorities explained that uncertainties surrounding the inflation outlook remain as oil prices have risen in recent weeks and food prices will be influenced by the south-west monsoon. In addition, the government’s actions on food management will be significant in determining the inflation forecast.
Regarding the recent revision to GDP statistics, the Central Bank pointed out that the new information presents a picture of a robust economy. However, the recently-released estimate is at odds with other economic indicators and anecdotal evidence on the state of the economy. Despite the contradiction, the Bank believes the overall portrait of a steadily recovering economy is accurate.
In addition, the Central Bank commented on the recently released Union Budget. The monetary authorities stated that many of the structural reforms contained in the Budget will improve supply over the medium term. In the near term, the Central Bank estimates that aggregate demand will be boosted by the one-year postponement of fiscal consolidation to a 3% target. Concern remains regarding the large borrowings planned for the public sector. Moreover, the government has pledged to compensate for the postponement by improving the quality of fiscal adjustment going forward. In addition, the government and the Central Bank signed a memorandum outlining clear inflation objectives and stating that fiscal and monetary policy will work together in a complementary method.
In conclusion, the Central Bank summarized that low inflation figures combined with some still-weak data in economic indicators justify its monetary policy action. The Bank added that the need for an unscheduled decision was prompted by the weak state of certain sectors of the economy and the release of the agreement on monetary policy framework. Looking forward, the Central Bank stated its target of lowering the inflation rate to 4% by the end of a two-year period beginning in FY 2016/2017. In addition, the RBI explained that, “further monetary actions will be conditioned by incoming data, especially on the easing of supply constraints, improved availability of key inputs such as power, land, minerals and infrastructure, continuing progress on high-quality fiscal consolidation, the pass through of past rate cuts into lending rates, the monsoon outturn and developments in the international environment.”