To give the slowing economy a boost, the Reserve Bank of India (RBI) on Wednesday cut its repo rate by an unconventional 35 basis points (bps) to 5.4% and kept the policy stance at “accommodative”.
However, this is not the first time that the RBI has taken such a decision. In March 2003, within a period of 13 days, RBI’s rate actions saw the repo rate decline by 40 basis points to 7.1%, and further reduced by 10 basis points to 7%. The repo and reverse repo rates were not interlinked as they stand now, but 25 basis points or multiples thereof were never a standard rule.
Explaining the rationale underlying this action, RBI governor Shaktikanta Das said that considering the evolving macroeconomic outlook, the Reserve Bank has been pre-emptive in its monetary policy actions and stance. Since February 2019, it has reduced the policy repo rate by a cumulative 75 basis points.
“It has changed its policy stance---from neutral to accommodative, which is effectively a further reduction in the policy rate, since it takes rate increases off the table while committing to either rate reductions or status quo, going forward,” said Das.
While the previous two monetary policy committee (MPC) meetings were conducted over two days, the August 7 policy action came after three days of deliberations where the MPC voted unanimously to reduce the repo rate and maintain the accommodative stance of monetary policy. “Four members voted for a reduction in the policy repo rate by 35 bps, while two members voted to reduce the policy repo rate by 25 bps,” said Das at the press briefing.
In the latest meeting, the MPC judged that with inflation projected to remain within the target, addressing growth concerns by boosting aggregate demand, especially private investment assumes the highest priority at this juncture. “Against the backdrop of policy actions taken so far, the MPC felt that it is prudent to remain accommodative,” said Das. “Accordingly, the MPC was of the view that the standard 25 bps might prove to be inadequate in view of the evolving global and domestic macroeconomic developments. On the other hand, reducing the policy repo rate by, say, 50 bps might be excessive, especially after taking into account the actions already undertaken,” Das added. “Reducing the policy repo rate by 35 bps was, therefore, viewed as a balanced level of cut under the circumstances.”
According to Suvodeep Rakshit, senior economist at Kotak Institutional Equities, while the RBI continued with its rate cut cycle, it surprised with the quantum–reduced repo rate by 35 bps. “While this induces some uncertainty in market expectations of the quantum of rate changes, it provides the RBI with a greater degree of flexibility in signalling their intent,” says Rakshit. “The 35 bps rate cut should be seen as a signal that the RBI is quite concerned with the growth outlook,” adds Rakshit, who sees scope for 25-50 basis points of further rate cuts through FY20.
“So far the RBI has reduced the repo rate by 110 bps which would benefit the demand in interest-sensitive sectors, mainly real estate, automobile, consumer durables, etc. as and when it is transmitted by the banking system,” says Arun Thukral, MD and CEO, Axis Securities. “Transmission is among the key factors for improving the investment climate in the country,” he added.
The RBI, too, has been conscious about monetary policy transmission. Das said that an easing cycle commenced in February 2019, with a cumulative reduction in the policy rate by 75 bps during February-June, with the stance of policy being changed from neutral to accommodative in June. While highlighting that the weighted average call money rate (WACR) has declined by 78 bps, market repo rate by 73 bps and 10-year benchmark G-sec yield by 102 bps, Das said that the policy impulses have been transmitted through financial markets fully.
“Banks, on the other hand, have reduced their interest rates on fresh rupee loans by 29 bps so far (February-June 2019),” he said. RBI’s interactions with various stakeholders, including both public sector and private sector banks, indicate that steps are being taken by the banks on an ongoing basis to progressively lower their interest rates so that the benefits of the policy rate reductions are passed on to the economy. “Accordingly, we expect higher transmission of monetary policy actions and stance by the banks in the weeks and months ahead,” Das added.
Das also said the MPC noted that global economic activity has slowed down since its meeting in June in an environment rendered hostile by elevated trade tensions and geopolitical uncertainty. Reflecting subdued demand, crude oil prices have fallen sharply since mid-May whereas gold prices have risen, propelled by increased safe-haven demand. “These developments exemplify the high uncertainty weighing on the outlook, amidst rising downside risks to growth,” said Das.
Additionally, MPC noted that, increasingly, central banks across the world are easing monetary policy, including through ‘insurance’ rate reductions, and are committing to maintaining accommodation in their policy stances. Meanwhile, inflation remained benign across major advanced and emerging market economies. “Financial markets have turned volatile on the back of the monetary policy stances of major central banks and the uncertainty generated by trade and geopolitical tensions,” Das added.
On domestic developments, the MPC observed that the south-west monsoon is rapidly catching up, with the cumulative rainfall being 6% below the long-period average (LPA) and 25 of the 36 sub-divisions having received normal or excess rainfall as on August 6. The India Meteorological Department has forecast normal rainfall in August and September. In areas sown under kharif crops, rainfall was only 6.6% lower as on August 2 compared to a year ago. Meanwhile, industrial growth, measured by the Index of Industrial Production (IIP), moderated in May pulled down by manufacturing and mining. Electricity generation also picked up on strong demand.
Further, the manufacturing PMI rose to 52.5 in July from 52.1 in June, underpinned by a pick-up in production, higher new orders, and optimism on future demand conditions. High-frequency indicators of services sector activity for May-June present a mixed picture. Indicators of rural and urban demand, as well as construction activity, weakened, whereas domestic air passenger traffic growth turned positive in June after three consecutive months of contraction. The services PMI expanded to 53.8 in July from 49.6 in June, on an increase in new business activity, new export orders, and employment.
Das said the MPC has revised the projection of real GDP growth down to 6.9% for FY20—5.8-6.6% in the first half and 7.3-7.5% for the second—with risks somewhat tilted to the downside, against 7% in its June resolution with risks evenly balanced. “The downward adjustment in the GDP growth projection was warranted by various high-frequency indicators, pointing to weakening of both domestic and external demand conditions,” said Das. “On the other hand, the MPC was of the view that the impact of monetary policy easing since February 2019 is expected to support economic activity, going forward.”
While the equity market was eagerly waiting for the RBI monetary policy meeting, a 25 bps reduction in repo rate was unanimously factored in. Despite the unconventional rate cut, markets weren’t impressed. In a volatile trading session, the Indian equity indices swung both ways before closing with losses of 0.9%, despite stable global markets. Ajit Mishra, vice president – research, Religare Broking, says the dovish monetary policy by the RBI failed to lift the domestic sentiments. “We have entered the last leg of earnings season and expect that stock-specific volatility would remain high,” says Mishra, who maintains a cautious stance on Indian markets.
Equity markets from a RBI policy standpoint have been depicting an interesting picture since April 2001. Out of 120 policy actions taken by RBI, on 64 instances there was no rate action. For the remainder 56 instances, the repo rate cuts (10 to 100 basis points) and hikes (25 to 50 basis points) were carried out on 28 instances. When the S&P BSE Sensex’s lows on the policy action day were compared to the previous day close, the difference ranged between rise up to 356.88 points’ jump and 702.31 points’ decline. In case of the repo rate hike, the difference ranged between 210.65 points’ increase and 646.58 points’ fall.