The Surprise Move By The Central Bank Of India

India made a move that surprised the market. It has cut the key interest rate for the second time this year. The central bank of India has lowered its policy repo rate by 25 basis points to 7.5% after making a similar cut in the middle of January. Repo rate means the level at which the central bank lends to commercial banks.

What was the reason for the surprise move?

The reason cited was a weaker economy. After the surprise move, the rupee rose by as much as 61.88 against the US dollar – the strongest since February. The benchmark BSE Sensex index rose by 1.4% to hit a record high of 30,010.91 for the first time ever since it reached the 30,000 mark. However, when the rates were cut in mid-January, economists have already predicted that it is the first of a series of a rate-cutting cycle.

Industries have long been complaining of the high interest rates and borrowing from the banks to make an investment was too expensive. The surprise move is welcome news for manufacturers of “Make in India”. It will also make loans for homes, cars and motorbikes a lot more affordable for consumers.

The second cut in the interest rates came just a few days after the long awaited first full budget for the Modi government. It looks like a vote of confidence from the central bank particularly since the finance minister gave himself another extra year in order to hit the 3% budget deficit target. This is specifically for the purpose of infrastructure spending so that more roads and bridges will be built.

According to the central bank governor Raghuram Rajan, softer inflation and the commitment by the government to fiscal discipline were behind the easing measure. In a statement, Rajan said “Softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6% in the second half.” Last year, India’s inflation has eased sharply due to the decline in the prices of oil but rose to an annual 5.11% in January. This is still below the reserve bank’s target of 6%.

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