The Reserve Bank of India ushered in a soft interest rate regime by cutting the repo rate by 50 basis points to support growth. The Governor, Dr D Subbarao, said he expects banks to cut both deposit and lending rates.

He indicated that the scope for further cuts is limited in view of underlying inflationary pressures and fiscal deficit concerns.

Excerpts from his interaction with the media:

What informed the rate cut?

This decision to adjust the policy repo rate was informed mainly by growth-inflation considerations. First, growth had decelerated from 7.7 per cent in the first quarter of last year to 6.9 per cent in the second quarter and 6.1 per cent in the third quarter.

Although growth may have been slightly faster in the fourth quarter, we expect last year's (2011-12) growth would be below the number 6.9 per cent put out by the CSO.

Our assessment is that the economy is operating slightly below trend. The second consideration is the moderation in inflation – headline inflation, which ruled around 9 per cent for much of 2011, has come down to a shade below 7 per cent for March 2012, and non-food manufactured inflation has come down from a peak of 8.4 per cent in November last year to 4.7 per cent, which is close to the average of 4.5 per cent over the last six years.

We are delicately balanced in the growth-inflation balance. And that if we grow as expected at 7.3 per cent this year, we will be growing close to the trend. The scope for policy rate adjustment in the future will depend on how the growth-inflation dynamics evolve. But purely on growth consideration, the output gap is nearly closed or will get closed shortly.

What is important in the growth-inflation dynamics is the adjustment in the fiscal deficit as indicated in the budget last month. And for adjusting the fiscal deficit, adjustment in subsidies is very important and a question that we deliberated in formulating this policy is that an adjustment in petroleum sector prices will engender what sort of inflation and how we might respond.

I've been advised that there will be a little price adjustment and that if petroleum sector prices are adjusted then subsidies are reduced. There will be some relative price shift and headline inflation will respond to that. But whether monetary policy should respond to that will depend on how that (rise in petroleum product prices) transmits, if at all, to generalised inflation. Because on the one hand pricing power in the economy is quite limited, so the possibility of that being passed on to output prices is quite low.

Meeting with Bankers

Bankers were sanguine about transmission both on the deposit and lending rates. As far as our understanding goes, monetary transmission should be quite effective because liquidity has eased and we have projected a money supply growth at 15 per cent and non-food credit growth at 17 per cent this year and that should provide sufficient room for both government and private sector to borrow.

The 125 basis points reduction in CRR that we had effected has reduced the funding cost of banks. You heard the SBI Chairman say that transmission has not fully taken place. So you have to factor in not only the action today, but the cumulative actions of the last several months. And we also have provided additional accommodation in Marginal Standing Facility.

Banks pricing power has come down. This 50 basis points repo rate cut should be a strong signal for adjustment of both deposit and lending rates.

Discussions with bankers also centered around discrimination across customers on deposit rates. The main point of the RBI was that deposit rates given to customers must be non-discriminatory, transparent and contestable. This is not micromanagement. Banks can calibrate their deposit rates as they want, whenever they want.

We also discussed the external sector situation. Again the discussions centred on migration taking place from FCNR deposits to NRE deposits. There was the question about whether FCNR rates could be calibrated. At the macro level, we have to take into account both the debt concerns and capital inflow concerns.

There was also discussion on asset quality. Even as asset quality is under pressure and it is likely to continue under pressure, banks have told us that they are keeping a strict vigil. Some banks have reported that by focussing on what they call small accounts they are able to improve asset quality. And with the Air India restructuring approved by the Cabinet they said concerns about aviation sector adding to asset quality concerns had reduced.

We told them to improve risk management practices and systems in order to detect bad loans even before they go bad.

Rate cut

We have veered to using trend rate of growth to indicate non-inflationary growth rate. That was above 8.5 per cent or around that before the crisis; after the crisis the RBI put out the rate at 8 per cent; now indications are that it might be around 7.5 per cent, (that is not an exact number, we don't have a very firm estimate, but it is around that ballpark figure).

So, if the growth is 7.3 per cent this year, the scope for rate adjustment is limited. But 7.3 per cent is not cast in stone. That could change. Inflation at 6.5 per cent that we projected is not cast in stone. That could change. So, if the growth-inflation dynamics change in either direction that will change our policy stance. So, I cannot really say how we will behave or how we will respond to each movement in the growth-inflation equation.

The scope for rate cut is limited. But it is not as if there is no scope at all. And it is not as if we will only go by growth or by inflation. We will take into account both. Even as these (growth and inflation growth) are projections, they are not cast in stone. They could change either way. And we hope they change positively i.e. upside on growth and downside on inflation.

Gold loans

There has been a rapid growth in gold loans. There was a concentration risk. It is not as if the business model or activity of a particular motivated this concern. This concern arose from concerns about systemic instability that could potentially arise. So, to avoid concentration risk and systemic instability, we have taken these measures.

> kram@thehindu.co.in

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