By  Rasananda Panda & Prashanta Chandra Panda, September 29,   2015 : Amidst the intense clamour for reducing the interest rates since last few months   finally the RBI could not withstand all the blandishments that it was resisting thus far. Rajan blinked. In its fourth monetary policy report, RBI has reduced the repo rate from 7.25 per cent to 6.75 per cent.

The announcement of rate cut by 50 bps (basis points) is a welcome move by the Governor Raghuram Rajan, as it was expected to cut the rate by 25 bps. Mr. Rajan in his statement mentioned that his decision to 50 bps rate cut is not a Diwali bonus. Rather it is based on the review of the present and progressing macro-economic conditions of the country.

Apart from the rate cut, the policy statement also includes unaltered CRR (cash reserve ratio) at 4 per cent of Net Demand and Time Liability; sustaining existing daily varying rate repos and reverse repos for easing liquidity; and, supply longer term repos of up to 0.75 per cent of NDTL.

Accordingly, the reverse repo rate is corrected to 5.75 per cent, and the Marginal Standing Facility, and the Bank rate is corrected to 7.75 per cent.

The reasons for the repo rate cut by RBI are based on various factors involving both the domestic and the global economy. In terms of global economy, emerging market economies (EMEs) has shown a moderate growth rate in recent times, along with deteriorated global trade. Again we are experiencing increased downside risks to growth.

US’s slow down in industrial production, EU’s migrant and Greek crisis, Japan’s weak private consumption and exports, China’s Yuan devaluation with poor domestic consumption market, and Brazil and Russia’s recession and runaway inflation, and South Africa’s structural constraints are the reasons for the moderate growth in the global market.

Especially, Chinese Yuan devaluation in the mid-August forced the Asian emerging economies to devalue their country’s currency in order to compete in the market economy. Imports from China becoming cheaper, pressure was on the Indian government and the manufacturing industry’s to produce products and sell them in the markets at cheaper rates than Chinese products.

On the other hand, Indian economy, though in a tentative recovery, is far from robust growth. For instance in agriculture, deficit south-west monsoon rainfall at 14 per cent, and production-weighted rainfall deficiency at 20 per cent has slowed down the economy. Manufacturing sector showing uneven growth in April-July, and external demand conditions have become weaker due to lower exports and cheaper imports.

Construction activity in the service sector has been affected due to less demand for cement, and unoccupied residential houses. Similarly though CPI has dropped sharply to its lowest in August, since November 2014 but the aggregate demand is not forthcoming. Weakening growth prospects in EMEs results in world trade volume growth is below world GDP growth. India’s exports on merchandise have declined considerably. Only lowered crude oil prices has compensated for the loss.

US’s status quo on Fed rate has also been considered while deciding the repo rate cut by RBI. In terms of foreign exchange, forex reserves increased by US $ 10.4 billion during the first half of FY16 with the weakening of economies in emerging markets.

A total of 125 bps repo rate cut by RBI for this year including today’s 50 bps rate cut would yield steady economic growth. It is expected to strengthen demand for investment in the upcoming days. Having agreed to the fact that India’s economic recovery is in progress, Rajan said, it is still far from robust. Also, the Governor revised the RBI’s growth projection downward to 7.4 per cent from the earlier 7.6 per cent for this year.

In the context of inflation target setting, Rajan mentioned that inflation would be a shade lower at 5.8 per cent in January, and the target of 6 per cent will be achievable. He also further emphasized that the real interest rate of around 1.5 to 2% is still highest in the world and therefore it will definitely attract investments both domestic as well as foreign.

If stock market response is an indication then the initial euphoria after the rate cut has subdued by the end of the day. This signals the fact that though it was expected but the impact of rate cut may not be wide spread in the economy in the times to come.

In additions, RBI has come strongly on banks for not transmitting the benefit of rate cut to have real impact on the economy. It is prompting state run SBI to cut their base rate by 40 basis points effective from 5th October. It is expected that other banks including big private banks shall follow immediately.

Further the Governor has advised banks to increase their supervision on assets and its classifications, mandatory disclosures and provisioning against lending. Reducing the risk weightage for affordable housing is another case. Other important thoughts are cutting of the ceiling on held to maturity SLR and with a road map for cutting the SLR till March, 2017.

Allowing corporate houses to issue rupee denominated bonds with five years maturity, changing the foreign portfolio investment limit in government securities from 30 billion dollar are definite boost for money market and bond market. This may reduce the Yield to Maturity (YTM) of government securities. Once market responds on this line we may enter into a zone of reducing the pressure on administrative interest rates. Thus we have the realistic scope of moving towards a reduced interest rate regime and less dependence on debt market. This is also a boost to the importance on equity and capital market.

Some concerns: The urban consumption may pick up with the rate cut. The rural consumption may not show a jump given the subdued demand condition in the short term. The deficient monsoon is the biggest worry. Overcapacity in several sectors has constrained the recovery in non-infrastructure sector.

High level of debts by large corporate sector, persisting stress in some of the highly capital intensive yet crucial sector to the economy such as coal, power, steel are some other concerns. Therefore, a repo rate cut by 50 basis points is certainly justified given the receding inflation risks and clamour for all quarters.

However its effectiveness in spurring an wider impact on the economy as a whole is not expected in the medium to long term unless otherwise the Government looks into sustained growth in capital expenditure and an increased momentum in obvious Central and State level reforms. With the fifth bi-monthly monetary policy statement due in December, 2015 and the mother of all elections i.e. Bihar elections over, it will be interesting to watch the matching response from both the sides of Raisina Hill. After all a blink can also construed as a wink.

• Rasananda Panda, Ph.D. Professor of Economics, MICA, Prashanta Chandra Panda, Professor of Economics, KIIT University with Inputs from Mr. Robin Infant Raj D.