India rejoices in rate cut economic boost

Reserve Bank of India (RBI) governor Raghuram Rajan sprang a pleasant surprise by cutting the repo rate, which banks benchmark their lending and deposit rates against, by 50 basis points (bps; 100 bps = 1 percentage point) to 6.75 per cent from 7.25 per cent.In another major policy announcement, Rajan allowed foreign investors to buy up to 5 per cent of government bonds. This is expected to lead to an inflow of an additional $5 billion by March 2016 and could cushion the shock of the expected outflow of dollars once the US Federal Reserve raises interest rates.He also indicated that further cuts could be considered when he said: “While the Reserve Bank's stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed.”This would include reviewing the returns on the small savings rate. Finance Minister Arun Jaitley, however, declined to set a time frame for such a review.“We are looking forward to the transmission of these cuts.... which will increase the potential medium term growth rates,” he said.The latest rate cut is expected to push domestic demand once banks transmit the lower rates to end consumers and industries. Prior to Tuesday's cut, most banks had reduced their lending rates by only 30 bps citing high cost of deposits and high levels ofnon-performing assets for which they have to make 100 per cent provisioning.“The latest move will rejuvenate our economy,” said Nilesh Shah, CEO of Kotak Mutual Fund.Industry has been clamouring for a rate cut to boost demand and kick start the investment cycle.Coming as it does just before the festival season, the rate cut could boost consumption of consumer durables and housing. In India, about 70 per cent of consumer durables and 85 per cent of housing is bought with the help of bank loans. High rates have held back demand in these sectors.“I expect lending rates to fall by a cumulative 100 bps over a period of time,” added Rana Kapoor, CEO of Yes Bank, India's fourth-largest private bank.Some experts, however, cautioned against expecting an immediate increase in growth rates. “There is a lot of slack in the system. Large capacities are lying unutilised. Companies will first wait to reach 100 per cent capacity utilisation before embarking on fresh investments,” an analyst said.The RBI, however, cut its projection for GDP growth this year from 7.6 per cent to 7.4 per cent. But experts said this projection appeared overly conservative and that if banks swiftly transmitted the lower rates to end users, it could lead to faster growth in the remaining months of this financial year.India's economic recovery has been patchy so far. “Manufacturing has exhibited uneven growth in April-July, with industrial activity slowing sequentially in July, although it has been in expansionary mode for the ninth month in succession. Industries such as apparel, furniture and motor vehicles have experienced acceleration. Furthermore, the resumption of growth in production of consumer durables in recent months, after a protracted period of contraction over the last two years, is indicative of some pick-up in consumption demand, primarily in urban areas,” Rajan said.The RBI also expressed confidence that inflation would remain within its comfort zone, though it may rise marginally in the near future as the “favourable base effects reverse”... but taking into account steps taken by the government, “inflation is expected to reach 5.8 per cent in January 2016, a shade lower than the August projection.”