IN: Reserve Bank of India

Tue Sep 29 00:30:00 CDT 2015

Consensus Actual Previous
Change -25bp -50bp 0bp
Level 7.0% 6.75% 7.25%

As, expected the RBI opted to lower interest rates again today. A 50 basis point reduction in the benchmark repo rate to 6.75 percent was at the more aggressive end of the forecast range although is unlikely to come as any real surprise to anyone. Accompanying this move, the central bank announced it was also reducing the reverse repo rate by an equivalent amount to 5.75 percent as well as cutting both the marginal standing facility rate and the Bank Rate by 50 basis points to 7.75 percent. However, the cash reserve ratio (CRR) stays at 4.0 percent.

The September ease raises the cumulative reduction in the repo rate so far this calendar year to some 1.25 percent. In line its earlier actions, the latest monetary stimulus reflects the RBI's concerns that growth at home is still too sluggish to ensure the attainment of its medium-term inflation goals (CPI inflation touched a new record low of 3.66 percent in August). In particular, the recovery in manufacturing has been especially patchy and characterised by continued excess capacity, decelerating new orders and a rising inventory/sales ratio.

Moreover, the effects of sluggish domestic demand have been compounded in recent months by a significant slowdown in key overseas markets and more general weakness of commodity prices.

Against this backdrop there was always going to be considerable pressure on the central bank from government and industry to cut borrowing costs again today. Indeed, another significant contributory factor was the persistent reluctance of banks to pass on in full the previous rate reductions announced since the start of the year. Up until today, commercial lending rates had fallen only 30 basis points since January, less than half the then 75 basis point reduction in the central bank's repo rate.

Looking ahead, a reduction in the official growth forecast for FY2015/16 by 0.2 percentage points to 7.4 percent suggests that the RBI is less than convinced about economic recovery prospects. However, it stressed that the 50 basis point cut should be seen as front-end loading and indicated that policy should focus on pinning inflation at about 5 percent by the end of FY2016/17. This suggests that while policy risks remain for additional easing, official rates could well now be on hold at least through December.

The central bank of India announces its monetary policy with regard to interest rates about every six weeks.

Although the RBI monitors many economic indicators - as indeed all central banks do - the RBI most closely monitors inflation. The level of interest rates affects the economy. Higher interest rates tend to slow economic activity while lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, fewer homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or for those who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India. The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.

The Reserve Bank of India performs this function under the guidance of the Board for Financial Supervision (BFS). The Board was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India. Primary objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies. Its function is to advise the Central Board on local matters and to represent territorial and economic interests of local cooperative and indigenous banks; to perform such other functions as delegated by Central Board from time to time. Primary objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies. The Board is required to meet normally once every month. It considers inspection reports and other supervisory issues placed before it by the supervisory departments.