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RBI's decision of no change in repo rate could boost real estate, BFSI, auto, FMCG

05-August-2015
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RBI's decision of no change in repo rate could boost real estate, BFSI, auto, FMCG

The Reserve Bank of India (RBI) during the monetary policy review decided to keep the interest rates unchanged despite mounting pressure from the government to cut rates. The repo rate will stay at 7.25 per cent and the cash reserve ratio will remain at 4 per cent. Moody’s Analytics which is a research and ratings firm said that the RBI could spring a surprise with a 25 basis points (0.25%). However, a poll conducted by a publication showed that 14 of the 15 economists expected the repo rate benchmark to stay the same.

The reason to hold on to current rates by RBI Governor Raghuram Rajan was due to the rise in inflation and also as the governor expects the previous rate cuts amounting to 75 basis points to reflect in the lending rates of banks. “Since the first rate cut in January, the median base lending rate of banks has fallen by around 30 basis points, a fraction of the 75 basis points in rate cut so far. As loan demand picks up in Q3 of 2015-16, banks will see more gains from cutting rates to secure new lending, and more transmission will take place,” said Rajan during the monetary policy meeting. The RBI monetary policy statement further pointed out that the consumer price index (CPI) inflation had risen for a second successive month in June 2015 to a nine-month high on the back of a broad based increase in upside pressures. While food based inflation had increased by 60 basis points over the preceding month, driven by a spike in prices of vegetables, protein items, especially pulses, meat and milk and spices.

“Given that policy action was front-loaded in June, it is prudent to keep the policy rate unchanged at the current juncture while maintaining the accommodative stance of monetary policy. We will look for more room to ease policy rate depending on fuller transmission of rate cuts by banks, food prices and US Fed normalisation signs,” said Rajan.

Effect on key sectors

Though the RBI decided not to cut the interest rates, there still seem to be positives in the monetary policy review for key growth sectors. A key takeaway being the central bank looking to see that the previous rate cuts are passed on fully by banks to borrowers. As suggested by the governor lending rates by banks have only dropped by 30 basis points and need to drop to 75 basis points. This will definitely ensure that interest rates are reduced and that people and companies will benefit from it. Some of the key sectors that will immediately benefit from this drop in interest rates by banks will be the real estate, BFSI and the automobile industries. However, other key sectors such as retail and FMCG will look to benefit as lower interest rates for borrowers will leave them with more money for discretionary spends.

The RBI’s efforts to control inflation have time and again helped to boost key sectors which are driven by consumer spends. As inflation eats into consumer income it restricts their discretionary spends which in turn impact sectors such as FMCG, retail, consumer goods, handset manufacturers, etc. With RBI’s efforts to check consumer inflation successful in spite of many factors such as crude oil prices and pricing of food, many of these key sectors are able to achieve higher growth. Growth in these key sectors has also enabled for higher ad and marketing spends in the media and entertainment space.     

Downplaying the controversies of government control

The RBI governor also downplayed the controversy that arose out of a drafted parliamentary bill by the government that sought to reduce the central bank’s independence on setting interest rates. The drafted legislation which was published last month had asked for the creation of an interest rate-setting committee (Monetary Policy Committee; MPC) which would have more than half the members appointed by the government and also removed the RBI governor’s veto power.

Rajan said that the responsibility and decision of setting rates so far is that of RBI governor. “Currently the situation is that the governor has a veto. All advice is only advice, ultimately the decision is the governor's, so if we continue to retain a veto. It doesn't change the current situation, it maintains the status quo,” he said. He further added the RBI has reached a broad understanding with the government on the composition of the monetary policy committee and what the governor’s power should be. The new committee should ensure the structure and continuity in the monetary policy he said. He also said that studies show that a monetary policy panel’s decision is better than those of an individual. Spreading responsibility can reduce external and internal pressure on an individual, he said.        

The government had received severe criticism on the draft parliamentary bill from economists and credit ratings agencies alike. Moody’s Analytics for instance last week had cautioned the government’s tampering with RBI’s independence would hurt India’s economic prospects. “We believe that a government-elected panel undermines the RBI's independence. Moving to the new model would severely dent the RBI's competency: Credibility would be lower, politics would drive decisions, and transparency would be reduced,” it said.

Since then various government bodies have been trying to distance themselves from who came up with the draft proposal for the Indian Financial Code (IFC) for the setting up of the committee. While the Chief Economic Advisor Arvind Subramanian said that the revised IFC draft was based on the report by the Finance Sector Legislative Reforms Commission (FSLRC). FSLRC member M Govinda Rao on Monday said that it was incorrect to call the revised draft of the IFC a report of the commission. He said the FSLRC term had ended in 2013. The Finance Secretary Rajiv Mehrishi too on Monday said at a press conference that the decision to remove the veto powers of the RBI governor was not a proposal of the FSLRC but also went on to deny that it was not even of the government. Trying to put the issue to rest he said that the people of India own this draft report and that the government is still seeking comments on it.

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