In a big surprise for the markets, the RBI on Tuesday cut the policy repo rate by 50 basis points to 6.75 per cent.
The equity market which was in the red till the announcement after a brief bounce back slipped into the red again.
The market was widely expecting the central bank to go only for a token 25 basis points cut in view of the deficit monsoon and expectation that the US Fed will raise interest rates by December.
The RBI said monetary policy has to be accommodative to the extent possible, given its inflation goals, while recognizing that continuing policy implementation, structural reforms and corporate actions leading to higher productivity will be the primary impetus for sustainable growth.
Furthermore, investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow. Therefore, the Reserve Bank has front-loaded policy action by a reduction in the policy rate by 50 basis points.
“Given our year-ahead projections of inflation, this ensures one year expected Treasury bill real interest rates of about 1.5-2.0 per cent, which are appropriate for this stage of the recovery,” the RBI said.
The RBI reasoned that since bi-monthly policy statement of August, 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 disinflation has been broad-based and inflation excluding food and fuel has also come off its recent peak in June.
The Federal Reserve, according to the RBI, has postponed policy normalisation. Markets have transmitted the Reserve Bank’s past policy actions via commercial paper and corporate bonds, but banks have done so only to a limited extent.
“Since our last review, the bulk of our conditions for further accommodation have been met. The January 2016 target of 6 per cent inflation is likely to be achieved. In the monetary policy statement of April 2015, the Reserve Bank said that it would strive to reach the mid-point of the inflation band by the end of fiscal 2017-18.
“Therefore, the focus should now shift to bringing inflation to around 5 per cent by the end of fiscal 2016-17,” the RBI said.