While nudging the banks once again to hurry up with the full transmission of its cut in repo rate (since January) to borrowers, the reserve bank of India did not change policy rates today.

The central bank on Tuesday kept its short-term lending and borrowing rates unchanged, in line with expectations. In its fifth bi-monthly monetary policy review of the current fiscal conducted by Reserve Bank of India Governor Raghuram Rajan in Mumbai, the repurchase rate at which short-term credit is extended to commercial banks was left unchanged at 6.75 per cent.

Accordingly, the reverse repurchase rate, or the interest paid by the central bank for short-term borrowings, also stood frozen at 5.75. per cent. The statutory liquidity ratio and cash reserve ratio that banks have to keep in liquid assets and government securities also remained intact.

The Reserve Bank of India also kept its overall growth projection for 2015-16 at 7.4 per cent and said the inflation target of 6 percent in January next year as set out in the previous policy update also was within reach, albeit with a slight downside risk.

Borrowers will have to wait till the RBI resumes its rate cuts - possibly after the Budget announcement early next year -- for lending rates to move substantially lower from hereon.

The RBI has lowered its key policy repo rate — at which banks borrow short-term funds from the RBI — by 125 basis points since January. While the central bank has done four rate cuts this year, what galvanised banks to lower lending rates was the steep 50 basis points cut in repo rate, in the previous September policy.

On an average, banks have reduced their base rates -- to which all lending rates are pegged — by 50-60 basis points since January; half of this was done post the RBI’s September rate cut and quick.

Despite lending rates moving lower by a substantial amount and across the broad, many argue that there is still room for more cuts. This is because; lending rate cuts are still far lower than the 125 basis points repo rate cut by the RBI since January.

One of the main reasons for slower transmission has always been that banks source only a small portion of their funds at the repo rate. With banks relying significantly on longer term deposits, only about 50-60 per cent of banks’ funding gets re-priced. Going by this, the RBI’s 125 basis point cut in repo rate, (at 50 per cent) then has been fully transmitted by banks.

Another reason for limited cuts in lending rates in the coming months, is also because public sector banks that have a lion’s share in lending are likely to be a lot more circumspect while cutting rates. Given their poor core performance and high level of stressed loans, lending rate cuts will only stress margins further.

Growth figures

On the growth front, Rajan said robust second quarter GDP numbers suggest that the economy is in early stages of recovery.  As per the Central Statistics Office (CSO), India’s GDP accelerated to 7.4 per cent in the July-September quarter, overtaking China as the world’s fastest growing major economy, on pick up in manufacturing, mining and services sectors.

Rajan said provisional estimates of gross value added (GVA) at basic prices for Q2 of 2015-16 rose on the back of acceleration in industrial activity.

“Other indicators suggest the economy is in the early stages of a recovery, though with some areas of continued weakness,” he said.

The GVA, a new concept introduced by CSO to measure the economic activity, also accelerated during the second quarter to 7.4 per cent, from 7.1 per cent in the April-June period.

Rajan further said that while there are areas of robust growth in manufacturing such as capital goods and passenger cars, weak rural and external demand holds back stronger overall growth.

Similarly, while prospects for a revival in service sector activity have been boosted by optimism on new business, pockets of lackluster activity such as construction weigh on the overall outlook.

Elaborating on the state of domestic economy, RBI said that value-add in agriculture and allied activities picked up on the modest increase in kharif output and timely policy interventions to stem the effects of the deficient south-west monsoon.

Turning to third quarter, it said the north-east monsoon commenced on a listless note, but the subsequent cyclonic weather has improved precipitation and raised the probability of a normal monsoon as predicted by the Indian Meteorological Department.

Nevertheless, the exceptionally dry start to the season affected sowing in all major rabi crops, while the excessive rains that followed may have reduced the prospects of coffee and paddy.

“Overall, the current outlook for agricultural growth in 2015-16 appears moderate at best at this juncture,” Rajan said.

On the performance of services sector, he said lead indicators are mixed.

Recent policy initiatives relating to rail, port and road projects are likely to improve construction activity, as will the Reserve Bank’s countercyclical reduction of capital charges on low income housing loans, albeit with gestation lags.

Pay panel impact

Meanwhile, Rajan on Tuesday said the seventh pay commission recommendations will not upset fiscal maths as additional expenditures will be offset by either surplus revenues or expenditure cuts.

In the monetary policy review, the reserve bank said the implementation of the pay commission proposals, and its effect on wages and rents, would be factored in by the RBI in its future deliberations.

"In the broad sense, yes there is going to be additional expenditure, but that will be offset presumably by either additional revenues raising or cuts elsewhere so that the fiscal consolidation path is maintained," Rajan said today.

The 7th Pay Commission has recommended increase in remuneration of about one crore government employees and pensioners which is estimated to impose an additional burden of Rs 1.02 lakh crore on the exchequer in 2016-17.

The new pay scales, subject to acceptance by government, will come into effect from January 1, 2016.

Rajan said the government had anticipated the consequences of pay commission recommendations and hence the fiscal path is expected to be maintained.

In the monetary policy statement, RBI said the direct effect of Pay Commission implementation and its "effect on aggregate demand is likely to be offset by appropriate budgetary tightening as the government stays on the fiscal consolidation path".

The government had unveiled a fiscal consolidation roadmap in 2015-16 Budget under which fiscal deficit was to be brought down to 3.9% of GDP this fiscal, 3.5% in 2016-17 and 3% by 2017-18, respectively. Fiscal deficit in 2014-15 was 4% of GDP.

RBI deputy governor Urjit Patel said the increase in the house rent allowance of government employees post Pay panel award would get reflected in the retail inflation data.

"But that is a one time level change and unless there are wider externalities, we will most likely look through that... The impact will be felt from April onwards for 6-8 months. You will see an index change, but that will likely be looked through by RBI," Patel said.

Several rating agencies and brokerages have said that a proposed 23.6% hike in salaries and pensions of government employees could hurt India's finances.