Repo rate cut by 0.25% : RBI and Government walk in step

First Bi-Monthly Monetary Policy Statement on April 5, 2016 by Governor Rajan 

Repo rate cut by 0.25%, but borrowing rates for end customers to come down more as a result of past measures. Long term finance, wholesale and custodian banks may see the light of day

Monetary Policy                                                                                                     2016-17

Governor Rajan announced a 0.25% cut in the key policy rate, the repo rate. With this the fixed rate at which banks borrow from the RBI comes down to 6.5%.

The RBI’s outlook on inflation sees no change from its earlier version in the last financial year: 5% CPI inflation by the end of the current financial year, 2016-17. My view expressed in my blog on April 1, 2016 was that under these circumstances the RBI should not reduce the repo rate at the April statement date, but should do so at the June or August statement dates after the picture on inflation became clearer, and the pass through of rate cuts by the RBI in the last financial year – altogether 1.25% - via banks to the end customer become stronger.

My view is that the RBI has complied with the government’s desire, which was made public by the Finance Minister himself two days before the April 5 statement.  In fact, the RBI itself makes the point that the rate cut is not really significant. This is what the monetary policy statement says very sensibly:

“Perhaps more important at this juncture is to ensure that current and past policy rate cuts transmit to lending rates. The reduction in small savings rates announced in March 2016, the substantial refinements in the liquidity management framework announced in this policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission and magnify the effects of the current policy rate cut. The stance of monetary policy will remain accommodative.”

In my April 1 blog, I had brought attention to the cut in small savings rates and the introduction of MCLR – these measures themselves will lead to further monetary easing feeding through to the end customer. In addition the RBI has introduced new measures to ease the mechanics and volume of its lending to banks via the repo rate. As these are quite technical, I will go into these in a separate blog, but the bottom line is that it looks like banks will typically be getting more short term liquidity from the RBI in the future.

Now what? I had indicated that 0.5% cut in the repo rate could well be expected in 2016-17. So another 0.25% cut in the repo is on the cards, assuming RBI’s inflation outlook for the year materialises.

The monetary policy statement contained one significant regulatory development: the RBI is continuing with its policy of issuing differentiated bank licenses. Last year saw the licensing of small finance and payment banks. This financial year the RBI is considering licenses for long term finance, wholesale and custodian banks. This is a welcome development.

In the conference call with media, Governor Rajan also stated that the on-tap licensing of universal banks will come into effect. This is another welcome development.