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Rajan holds rates in his final RBI policy, keeps repo rate at 6.5%

Inflation at a two-year high will probably prevent Raghuram Rajan from cutting interest rates at his final policy review as head of the Reserve Bank of India on Tuesday.

business Updated: Aug 09, 2016 11:12 IST
Raghuram Rajan

Reserve Bank of India (RBI) Governor Raghuram Rajan looks on before delivering a lecture in Mumbai in June , this year.(Reuters)

On expected lines, RBI governor Raghuram Rajan on Tuesday kept policy rate unchanged at 6.50%.

Inflation at a two-year high prevented Rajan from cutting interest rates at his final policy review as head of the Reserve Bank of India .

In the policy statement, RBI kept a positive outlook on the economy saying abundant monsoon will help in the recovery.

As Rajan presented his final monetary policy, the government has still to pick a successor to the highly respected former International Monetary Fund chief economist.

But when he walks away on September 4 to return to academia and family living in the United States, Rajan will be relieved that he leaves behind a government that last week formerly adopted the consumer price inflation targets he had set.

The move vindicates Rajan’s policies on a no-holds-barred strategy to rein in prices and keep inflation well below interest rates on fixed deposits.

The approach, which won him few supporters and in fact, helped the din against his re-appointment, also underscores the government’s tacit agreement that the environment is not conducive for a rate cut. That is probably what will happen on Tuesday too.

The third bi-monthly monetary policy for this fiscal will likely retain the repo rate — the rate at which banks borrow short-term funds from RBI — at 6.5% as retail inflation is still above RBI’s targeted level.

According to the central bank’s own projections, consumer price index (CPI)-based inflation should come down to 5% by January 2017 and anchor in at 4% by March 2018. So, chances of a rate cut even in the remaining part of 2016-17 look remote.

What is now important is to know what will be left on the plate for Rajan’s successor.

For starters, there is the formation of the monetary policy committee (MPC) that Rajan feels can institutionalise the mechanism of setting interest rates. The composition that saw initial run-ins with the government, will now be equally divided between the central bank and the government, with the RBI governor having the casting vote. “This creates an institution that many other countries have adopted, which India was slow to adopt,” Rajan had said during a recent meeting of central bankers.

Much has been written about Rajan’s efforts to rid the banking system of the huge bad loans it had taken upon itself. In the past two years, RBI has asked banks to recognise bad loans early on and make provisions for them, besides rolling out debt restructuring exercises.

But the central bank is still striving uphill. There is still much to be done and much more to do to make companies and banks take harsh decisions.

Bank licence is another area where RBI has a lot to cover. While it has successfully kept away large business houses from owning banks, small finance banks and payments banks are yet to develop. The latter has already seen teething problems with shortlisted applicants abandoning their ventures on grounds of viability — enough to prompt RBI to issue veiled warnings of penalties. But screening of applicants and selecting serious players is less than half the battle; use of technology to allow the poor to transfer money, at low costs, is a big task.

Then there are areas such as the bond market and financial inclusion. But the biggest feature of Rajan’s legacy and one that the new governor will have to carry forward, is to strengthen RBI’s independence. The role of the financial regulator will also have to be aligned with financial sector reforms. That would be one of the biggest items on the plate.

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