After an unconventional 35 basis-point move in August, the RBI reverted to a 25-point reduction, disappointing bond investors who had expected a more aggressive reduction. The benchmark stock index and the rupee fell, reversing early gains, while yields on India’s 10-year bonds jumped 4 basis points to 6.65 per cent.
The market reaction reflects “over-exuberance about bigger rate cuts getting dented,” said Naveen Singh, head of fixed-income trading at ICICI Securities Primary Dealership in Mumbai. There’s also some disappointment that the governor himself voted for just a 25 basis-point cut, he said.
The government’s recent fiscal measures, including a $20 billion tax break for companies, have given the RBI room to shift to a more gradual pace of easing again. Das said the measures announced by the government over the last two months are expected to revive sentiment and spur domestic demand, especially private consumption.
What Bloomberg’s economist says
“The Reserve Bank of India’s baby-step rate cut of 25 basis points isn’t enough to reverse a severe slump in the economy. The sharp downgrade of its full-year growth outlook shows it recognises the extent of the challenges.”
The RBI has cut rates by a total 135 basis points so far this year, prompting some economists to question how much more easing room the RBI has.
“I think they have done enough and, given a considerable policy transmission lag, they should allow the easing so far to bear fruit,” said Prakash Sakpal, an economist at ING Groep NV in Singapore. “Or else, the authorities are running the risk of aggressive fiscal and monetary pump-priming eventually fueling inflation.”
While the RBI underlined a dim global growth outlook as a risk to domestic expansion, it is also facing mounting problems in the banking system. It recently imposed withdrawal curbs on a small bank and lending restrictions on another lender.
The “RBI would not allow a cooperative bank to collapse,” Das said, referring to an almost $1 billion scandal at a small bank. Talks are on with the government on regulation of tiny banks, he said, seeking to reassure the market about how the banking system “remains sound and stable.”
The central bank raised its near-term inflation forecast slightly to 3.4 per cent for the second quarter of the fiscal year started April, while projecting it would stay below its medium-term target of 4 per cent -- a level it has undershot for 13 straight months.
The government said the revised inflation forecast is still within the central bank’s target. The rate decision will complement its efforts to boost growth.