Rate cut should lead to fall in deposit, lending rates: Subbarao

Reserve Bank of India Governor Duvvuri Subbarao said on Tuesday that the RBI’s move of effecting a deeper-than-expected 50 basis points cut in the repo rate was prompted by growth-inflation considerations. But he said the central bank’s growth and inflation estimates were ’not cast in stone’. He said one of the reasons for the extent of the rate cut was also to send a stronger signal for effective transmission of these cuts by banks.

“As far as our understanding goes, monetary transmission should be quite effective because liquidity has eased. The reduction in CRR (cash reserve ratio) which we have effected has also reduced the funding cost for banks,” Subbarao told reporters at a press conference after announcing the RBI’s Monetary Policy for 2012-13. The RBI had slashed CRR by 75 basis points before the Budget.

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“You’ve heard the State Bank of India chairman tell you that transmission has not fully taken place. So whether there will be further transmission from this point, you will have to factor in not only the action today but also the cumulative action of the past several months,” the RBI governor said. Banks’ pricing power has also come down. “We could have done 25 bps, but this 50 bps itself should be a stronger signal for adjustment of both deposit and lending rates.”

Explaining the RBI policy action, Subbarao said there had been a moderation of both headline and core inflation, with headline inflation coming down from around 9 percent levels in 2011 to just a shade under 7 percent now. Non-food inflation had also come down to 4.7 percent, and was under 5 percent for the first time in two years. “We are delicately poised in the growth-inflation balance and the growth has been projected at 7.3 percent this year,” he said.

On the Budget and the fiscal scenario

Subbarao said the budget’s plan of bringing the fiscal deficit down from 5.9 percent in FY12 to 5.1 per cent this fiscal would be taken by RBI “at face value” which, he said, was a ‘sizeable adjustment’. “But like everyone else, we are also very concerned about the government delivering on that. Therefore, we reiterated the message this time about the importance of delivering on the 5.1 percent, in particular that the adjustment of subsidies is necessary, although not sufficient, for the delivery of the 5.1 percent,” Subbarao said. He underlined, however, that other considerations and the new inflation and growth numbers which have come in also prompted RBI’s rate action.

On the adjustment in petroleum sector prices, he said there would be relative price adjustment, and headline inflation would respond to that. “But whether monetary policy will respond to that will depend on how that transmits, if at all, to generalised inflation,” he said.

He said the RBI knew as much as anyone else whether the government would deliver on targets but pointed to some measures the government was taking to ease supply side constraints on power, energy, food, labour and other sectors. He also said the measures underlined in last year’s budget and reiterated in Budget 2012 were also showing the government’s intent. “The government has also been focusing on infrastructure, roads and the like.”

Growth and inflation

The potential growth rate, he said, was a textbook concept. Hence, the RBI veered towards a “trend rate of growth” which was essentially a non-inflationary growth rate. Before the crisis, that trend rate was at 8.5 percent, which fell to 8 percent after the crisis and now indications are that the rate is around 7.5 percent. “But this is not an exact number. We don’t have a very firm estimate, it is a rough ballpark,” Subbarao said.

“So if we do get 7.3 percent this year, the scope for rate adjustment is limited. But 7.3 percent is not cast in stone. That could change. The 6.5 percent is also not cast in stone. So if the growth-inflation dynamics change in either direction, that will change our policy stance,” the governor explained. “We hope they change positively. Upside on growth and downside on inflation.”

RBI’s comfort zone on inflation

He said the RBI’s medium term goal remains 3 percent on inflation and that commitment persists. “We still believe that the 5 percent that we had for much of the 2000s is still something to strive for and once we get to 5 percent we should get to below 5 percent, our medium term target,” he said. “The threshold inflation level for us is 4-6 percent in the context of the growth-inflation tradeoff. He said the RBI was looking at all the inflation numbers - core inflation, WPI, and CPI - while making its decisions.”