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RBI policy move keeps markets guessing

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The limited explanation on the Reserve Bank of India’s lowering of the real interest rate and the time to be taken for achieving the four percent Consumer Price Index(CPI)inflation target has markets guessing on the trigger and implications.
The central bank got room to effect a 25-basis point(bp) rate cut due to a change in its stance on the neutral real rate and the time frame for achieving the inflation target.
Global financial group Citi said the real interest rate band of 1.5 to two percent the previous RBI governor,Raghuram Rajan,had talked about had been lowered to 1.25 percent. The real interest rate is the difference between CPI-based inflation and yield on one-year treasury bills. With inflation at five percent and the repo rate now at 6.25 percent,there is no space to further cut the latter, unless inflation surprises further on the downside.But, the lowering of the real interest rate band is surprising.RBI did not elaborate on why,except to say it changes over time.
Religare, adomestic financial services unit,said RBI’s repo cut was shrouded by cautious commentary over the inflation trajectory.RBI did not give a specific time line to achieve the four percent inflation target.
Taking a real rate of 1.25 percent,an inflation rate off our percent corresponds to are porate of 5.25 percent in the medium term.This suggests a 100-bp interest rate cut is likely if inflation moderates to around four percent,said Citi.
One analyst with a rating agency said in the absence of a detailed explanation on major changes,it was back to “reading tea leaves and making own interpretations”.
Nomura, inanote, said the realrate(one-yearT-billrate minus expected inflation)target had been lowered from 1.5-2 percent to 1.25 percent,based on the argument that neutral real rates had moderated globally.True, althoughth is argument was not made earlier. Also, with global neutral real rates closer to zero,we are not sure about the sanctity of the new number(1.25percent),and think it could well be lowered even further,Nomurasaid.
Business Standard New Delhi,06th October 2016

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