Further Monetary Easing aimed at Bolstering the Economy

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CEIC India Data Talk - October 15, 2015 The Reserve Bank of India (RBI), India’s central bank, cut its policy interest rate in September 2015 for the fourth time since January 2015, and by a larger-than-expected amount. The repo rate, the RBI’s benchmark policy rate was reduced by 50 basis points to 6.75%, when many had expected only a 25 basis points reduction similar to its last three policy rate cuts. The cut in September 2015, which brought its policy rate down to a four-and-a-half year low, highlights RBI’s shift in focus towards promoting economic growth over its mandate of managing domestic price growth as inflation has been running at a record low. Consumer price inflation has been below RBI’s inflation target of six percent since September 2014, declining steadily to 3.66% in August 2015, thus providing more leeway for lowering the interest rate to provide a lift to the economy. This expansionary monetary policy will likely spur domestic credit extended by the financial sector in India as the RBI seeks to boost economic growth. Lending activity, an indicator of investment demand and overall economic activity, has been weaker than usual. Domestic credit growth slowed to 6.16% year-on-year (YoY) in March 2015 from 11.20% YoY in March 2014, a sharp slowdown in contrast to the consistent double-digit growth experienced prior to June 2014. Nevertheless, domestic credit has since rebounded moderately to 9.64% YoY in August 2015, likely in response to the RBI’s three interest rate cuts since the beginning of 2015. Cheaper loans provide incentives for more borrowing, giving a boost to capital expenditure in the commercial sector. The “front-loading” of the interest rate reduction (given the RBI could have implemented more gradual cuts) should further encourage businesses to bring forward their borrowing and investments to take advantage of the low cost of credit, increasing credit growth. India’s financial market on the other hand may face a larger capital outflow, especially in view of the impending policy rate hike in the United States. Induced by the anticipation of a rate rise from the US Federal Reserve, in addition to the monetary easing in India, foreign institutional investors have been selling Indian equities and debt on a net basis for four of the five months since May 2015, a common market movement experienced by other emerging market economies. The direct effect is more apparent for bonds as the lower policy rate has placed downward pressure on yields. India’s benchmark 10-year government securities yield fell to 7.54% towards the end of September 2015, from 7.86% at the end of 2014. As yields fall – and the price of bonds by implication increases – investors shift their funds to seek better returns elsewhere. Despite the negative impact on India’s financial market, RBI’s interest rate easing is warranted as it provides the much-needed boost to investor confidence and demonstrates RBI’s commitment to promoting economic growth. Business confidence in India has been waning since the start of 2015 with the Business Optimism Index by Dun & Bradstreet experiencing a double-digit YoY decline for three consecutive quarters since the first quarter of the year. Moreover, the International Monetary Fund has also cut its global growth forecast for the second time this year to 3.1% for 2015. This lack of global demand further strengthens the case for stimulating domestic demand through monetary easing. However, the effect of any changes to the policy rate on the financial market and the economy will still depend on the reaction of financial institutions in India which have an incentive to uphold higher interest rates to protect their profit margins. Given the past record of lenders being slow to reflect lending rate cuts to borrowers, the RBI has pledged to work with the government in making sure the benefits from this monetary easing are fully transmitted. By Woon Khai Jhek - CEIC Analyst Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog

15th October 2015 Further Monetary Easing aimed at Bolstering the Economy

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