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RBI Cuts Rates 0.25%, Back to Sep 2013 Levels. We Didn't See This Coming!

RBI Cut Rates by 0.25% in a surprise move today. We were surprised, and we have been watching RBI closely. Rates are down by 0.25%.


This brings rates to where Rajan had first raised them (on 20 Sep 13) when India was in the middle of a big crisis.

The Statement has this, emphasis mine:

The new CPI rebased to 2012 was released on February 12, 2015. Inflation in January 2015 at 5.1 per cent as measured by the new index was well within the target of 8 per cent for January 2015. Prices of vegetables declined and, hearteningly, inflation excluding food and fuel moderated in a broad-based manner to a new low. Thus, disinflation is evolving along the path set out by the Reserve Bank in January 2014 and, in fact, at a faster pace than earlier envisaged.

The uncertainties surrounding any inflation projection are, however, not insignificant. Oil prices have firmed up in recent weeks, and significant further strengthening, perhaps as a result of unanticipated geo-political events, will alter the inflation outlook. Other international commodity prices are expected to remain benign, given still-sluggish global demand conditions. Food prices will be affected by the seasonal upturn that typically occurs ahead of the south-west monsoon and, therefore, steps the government takes on food management will be critical in determining the inflation outlook. Finally, the possible spill over of volatility from international financial markets through exchange rate and asset prices channels is also still a significant risk.

Perhaps the most significant influences on near-term inflation will be the strength of aggregate demand relative to available capacity. Two recent developments pertaining to the demand-supply balance are the recently-released GDP estimates and the Union Budget for 2015-16.

The Central Statistical Organisation is to be commended on the changes it has made to the methodology of estimating GDP, bringing India up to international best practice. Yet the picture it presents of a robust economy, with growth having picked up significantly over the last three years, is at odds with still-low direct measures of growth of production, credit, imports and capacity utilisation as well as with anecdotal evidence on the state of the economic cycle. Nevertheless, the picture of a steadily recovering economy appears right.

The fiscal impulses in the Union Budget then assume importance. There are many important and valuable structural reforms embedded in this Budget, which will help improve supply over the medium term. In the short run, however, the postponement of fiscal consolidation to the 3 per cent target by one year will add to aggregate demand. At a time of accelerating economic recovery, this is, prima facie, a source for concern from the standpoint of aggregate demand management, especially with large borrowings intended for public sector enterprises.

Some factors mitigate the concern. The government has emphasized its desire to clean up legacy issues which gave a misleading picture of the true extent of fiscal rectitude, and has also moderated the optimism in its projections. To this extent, the true quantum of fiscal consolidation may be higher than in the headline numbers. Also, the government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower. Furthermore, supported by lower international energy prices, there is a welcome intent to shift from spending on subsidies to spending on infrastructure, and to better target and further reduce subsidies through direct transfers. Finally, the central government has signed a memorandum with the Reserve Bank setting out clear inflation objectives for the latter. This makes explicit what was implicit before – that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way.

Finally, the rupee has remained strong relative to peer countries. While an excessively strong rupee is undesirable, it too creates disinflationary impulses. It bears repeating here that the Reserve Bank does not target a level for the exchange rate, nor does it have an overall target for foreign exchange reserves. It does intervene on occasion, in both directions, to reduce avoidable volatility in the exchange rate. Any reserve build-up is a residual consequence of such actions rather than a direct objective.

The guidance on policy action given in the fifth-bi-monthly monetary policy statement of December 2014 is largely unchanged. 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.

What they’re saying, and we should have heeded earlier is:

  • Look, the data is good. 5.1% warrants a rate cut.
  • The budget shows signs that government is cutting deficits. Intent is good, infra spend is good, subsidy retargeting is good. So we think that issue is not a concern.
  • There are problems – oil prices, slippage in fisc, higher demand due to increased gov spending and international stuff.
  • We’ll take action as data comes by, with pass through of past rate cuts being necessary. Fisc will be watched, as will supply issues and so on.

We’ve been silly – till recently we kept saying the data is the prime source of RBI action and the data was indeed good. The recent data points of:

  • Freight hikes
  • Petrol hike
  • Service Tax Hike

were our thought of why he might not cut just yet. But that’s going to affect inflation in the future, and I’m sure we get to wait until the effect happens.

Still, at 7.5% we don’t think the rate cut is done – we should see rates fall to 7% or lower in the medium term.


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  • Ravi says:

    “RBI Cut Rates by 0.75% in a surprise move today. We were surprised, and we have been watching RBI closely. Rates are down by 0.75%.”
    typo mistake in the content. it has cut by 0.25% but says 0.75%

  • Karthika says:

    Any thoughts on why the 10 year gsec yield has not fallen to somewhere near 7.5% even after the rate cut?
    Before the last rate cut in January, the market was discounting it and the yield was around 7.85%. I am wondering why it has not behaved the same way during this rate cut.
    Is the market not expecting any more rate cuts in the near future?

    • I guess not 🙁 Even stock markets crashed!

    • DJ says:

      Actually, if we had proper bond markets,, long end of the curve would have different response than short end. As an example, lower short rates could suggest to the market that longer term inflation (and thus longer term rates) will be high, so you could even have the opposite reaction in the long end vs the short end. We basically have one rate in our interest rate curve, so we have gotten used to same movements along the curve (most of the time), but it might be changing… Basic point I’m making is that long end of the rate curve has (or should have) different dynamics than short end (and movements could even be opposite to each other).

      • Actually we do have a yield curve. bond trading has gotten much more liquid lately. And we did have a badly inverted yield curve – even today, 91 day t-bills auctioned at 8.23% while the 10 year is at 7.67%.

        • esotericBlue says:

          i’m curious how does/can an individual participate in the t-bills market. could you post some pointers?

        • Cannot easily do so right now. There are sites like SBI Gilts and IDBI Gilts that say they allow you but we don’t know how complex that is yet…

  • Bank has to reduce their base rate otherwise No benefit to Common person.

    • Gold Bug says:

      Don’t worry about common persons. I have heard stories how common persons are milking banks via personal loans. Insiders in the Banks prepare fake IT returns for the last three years and will make you eligible for personal loans from banks based on those returns.

  • Gold Bug says:

    In May 2013 when the FIIs were pouring into G-Sec, everybody in India also joined the party.
    Immediately within 2 months FIIs pulled out fearing end of QE in US and immediately G-Sec Yield shot up to 9.2. RBI in the bid to stop short term borrowing by Speculators to drive down the Rupee, increased the Short term rates much higher then Long term rates. That time everybody was talking about Ultra Short term Funds.
    Now since Jan Uzbekistan started the Ball rolling by cutting rates and every other weak economies (including war threatened Turkey) have cut rates. India (with BBB) rating has also joined this race to bottom.
    With NIRP in Europe, Strong Dollar etc. Money is once again chasing all Junks (including India).
    This party will come to end at the moment as soon as panic about US rate increase surfaces. May be one or two quarters.
    That time Indian Rupee will be devastated and Bond Yields will climb.
    I am planning to book profits in my G-Sec funds and park it in Arbitrage funds to protect my capital. Even Gold will be better under that situation.