In the last 15 months, the RBI has reduced the rates by 125 basis
points. Here are some reasons why RBI governor Raghuram Rajan may reduce the rates further.
While the RBI Governor Raghuram Rajan may oblige the bankers by infusing more liquidity into the system, there are strong expectations of further reduction of repo rate, the rate at which it lends to bank, by another 25-50 basis points from the current level of 6.75 per cent. In the last 15 months, the RBI has reduced the rates by 125 basis points. Here are some reasons why it may reduce the rates further.
Fiscal deficit in the comfort zone: There was lot of uncertainty in the fiscal deficit numbers as a run up to the Union Budget. The fiscal deficit is now well within the target of 3.9 per cent for 2015-16. The target for current year 2016-17 at 3.5 per cent is also within the specified limit of Fiscal Management Responsibility Act (FMRB). Rajan has already gone on the record to say that country's fiscal deficit in 2016-17 is in the comfort zone of the RBI.
CPI in a downward territory: The Consumer Price Index or the retail inflation that RBI uses as a benchmark for deciding interest rates is on a downhill journey from the double digits a year ago. In the last released inflation series of February, the CPI was at 5.69 per cent. While the current number is higher than the RBI's target of 5 per cent by next March , there are enough indication of inflation not posing a danger. The falling commodity prices globally provides a biggest relief to the central banker. In fact, the pressure is also off from Governor's shoulders as the new monetary policy committee will soon decide the interest rates.
Reduction of small savings rate: The small savings rate has been a hot political potato for any government in power at the centre. The BJP led NDA government has taken a call to reduce small savings rate. The 1-year deposit rate has been reduced from 8.4 per cent to 7.1 per cent. It has also reduced the PPF rate from 8.7 per cent to 8.1 per cent. In fact, bankers have often mentioned that how a higher small savings rate discourages them to reduce deposit rates as there is a danger of funds flowing from banking sector to the post office.
New framework for faster monetary policy transmission: Rajan has stayed away from reducing interest rates aggressively because of a delayed transmission of rates from banks to final borrowers. Take for example, despite cutting repo rate by 125 basis points, the banks reduced the interest rates by less than 50 basis points. Rajan has now kicked in a marginal cost of funding method to fix the rates for banks from April onwards. This marginal cost method will result in faster transmission of rates.