RBI leaves rates unchanged but talks down expectations

The Reserve Bank of India left benchmark interest rates untouched in its quarterly credit policy statement, released today. That was as expected. But RBI Governor D. Subbarao, has made it clear that once clear signs of a recovery are evident, and if prices are ruling higher, the RBI will move swiftly to hike rates. At present, it is holding back pre-emptive action, to give room for consumers to borrow and buy and thereby generate demand for industries to grow. And, it is also allowing the government to borrow to fund the gap in its books. Once these factors cease to matter, one can expect interest rates to rise again.


  • All key benchmark rates have been left unchanged. What this means is that the RBI thinks, that there is enough money for those capable enough to borrow, and the banks have enough money to lend to such borrowers. And, credit and industrial growth is not being hampered by any factors in its control.
  • The RBI’s last statement in its policy review is worth noting. It says that it will maintain an accommodative monetary policy stance –low interest rates and ample liquidity in the system- till there are robust signs of a recovery. Once a recovery becomes evident, it will take steps to rein in inflation. And, it will have to reverse the expansionary policies it has taken over the past few years.
  • There is still headroom in the market for lowering rates, as banks have not cut rates in the same proportion as RBI has lowered its benchmark rates. SBI in fact cut its deposit rates recently which will give it leeway to cut interest rates down the line. Interest rates may soften a bit more. But interest rates will go higher over the next 6-12 months.
  • Why can’t interest rates stay at the same level? Answer: inflation. This may seem bizarre, because inflation has been running negative for months now. But that is a statistical illusion, because of a high base during this period last year. Prices have begun going up and this will reflect in the official numbers soon. The RBI expects the official numbers to start going up after October 2009.
    And, unfortunately, food inflation is already very high, affecting household budgets. Companies are enjoying lower input prices but are holding on to product prices, to enjoy higher margins. Now, input prices have started going up and they will use that as an excuse to hike prices. Many companies have reported an improvement in margins in the June 2009 quarter.
  • Growth too has picked up and the first two months’ industrial production has seen an uptrend in numbers. By October 2009, this trend too will have strengthened, coinciding with a period when inflation is high. An increase in economic growth accompanied by higher inflation is a factor that worries central banks.
  • The RBI has projected GDP growth of 6% with an upward bias. It expects export demand to remain weak till the global economy recovers. A weak monsoon may affect agriculture’s contribution to the economy. It expects inflation to be at around 5% by the fiscal year end compared to the 4% that it had projected earlier. Now, that should be a signal, while its growth expectations have not changed much, its inflation expectation has gone up. The RBI has said that it would be happy if inflation ranges between 4-4.5%.
  • The RBI has spelled out the challenges it faces in three time frames.
    1. Immediately, it has to manage the pressure of ensuring there is enough money in the system to help industry get back on its feet and at the same time, ensuring that inflation does not shoot back to the high levels seen a few years ago.
    2. The second immediate challenge is to ensure that a massive government borrowing programme goes through smoothly. The RBI will try its best to shield the private sector market from its effects. While it may be able to ensure that liquidity does not get affected, since the market yield on government bonds have increased, it may have some effect on borrowing costs in the economy.
    3. The third immediate challenge is to revive capital formation or investment by industries. That is a noble thought because the RBI has little control over that. Industries will first savour the return of demand growth and higher prices. Only when their machines start groaning at being overloaded with work, will they buy more machines. This will not happen in the current year, at least.
    4. The fourth short to medium term challenge is also a hope and a political one at that. The RBI wants the government to lay out a roadmap to bringing the fiscal deficit down to acceptable levels. It has rapped the government for not laying out a roadmap for this process, instead of specifying revised targets. The RBI wants to know how revenue will be increased and expenditure controlled. It is also interested in the quality of fiscal adjustment. So, revenues from 3G and disinvestment may bring in loads cash, but that is only postponing the problem. Fiscal health can improve only if sustainable revenue streams can be generated (read higher taxes) and expenditure can be cut (this is of course a pipe dream).

Read this Reuters story for fund manager reactions to the credit policy.

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