Raghuram Rajan's Diwali gift: A 50 bps cut in repo rate

The RBI Governor Raghuram Rajan on Tuesday surprised with a 50 basis points cut in the policy rate - the short  term lending (repo) rate - from 7.25 per cent to 6.75 per cent. The expectations in the market was for a quarter basis points.  
 
This is in all probability the last reduction  for 2015 year.

The trigger for  higher than expected  cut is the sustained fall in the headline consumer price index (CPI) inflation, which has  reached its lowest level in since November last year.

The RBI, however, says the inflation is likely to go up from September for a few months as favourable base effects reverse. "There are risk to inflation from monsoon outcome and also global developments. There are also risks to inflation from services sector," cautioned Rajan.

The RBI's estimates  for inflation is around 5.8 per cent by January 2016. The CPI target set by RBI under the new monetary policy framework was at 6 per cent  by January 2016. This, according to RBI,  has been achieved and hence a further accommodation in the policy rate.  
In the bi-monthly policy statement of August last month, the RBI has indicated that further monetary policy accommodation will be based on further easing of inflationary pressures, the full monsoon outturn, possible Federal Reserve actions and greater transmission of its front-loaded past actions.

The RBI says, "Since then, inflation has dropped to a nine-month low, as projected. Despite the monsoon deficiency and its uneven spatial and temporal distribution, food inflation pressures have been contained by resolute actions by the government to manage supply. The Federal Reserve has postponed policy normalisation."

On the transmission of lower rates to borrowers,the  RBI has said that the markets have transmitted the past policy actions via commercial paper and corporate bonds, but banks have done so only to a limited extent. "The median base lending rates of banks have fallen by only about 30 basis points despite extremely easy liquidity conditions.....further transmission is possible," hoped RBI.

"We want to encourage faster transmission. We are going to work very hard on this (transmission) with the government," Rajan said.