RBI does a hat-trick on rate cuts

After the election results were out, the markets were eagerly awaiting the economic data on the gross domestic product (GDP) for FY19, and the interest rate action from the Reserve Bank of India (RBI). While the decline in GDP growth rate data was a spoiler, the market had long factored in a rate cut from the central bank.

As expected, RBI delivered a 25-basis points (100 basis points make a percent) cut in the repo rate bringing it down to 5.75%. With the June 6 rate action, repo rate is down to a near nine-year low. The last time the repo rate was at 5.75%, was on July 27, 2010, when the RBI hiked repo rate from 5.5% to 5.75%.

Yet, the rate action has failed to please the markets at large. The S&P BSE Sensex fell by over 602 points from June 5 close of 40,083.54 to the day’s low of 39,481.15. Similarly, the Nifty50 fell over 191 points from June 5 close of 12,021.65 to the day’s low of 11,830.25. At close, the Sensex and Nifty 50 fell by 553.82 and 177.9 points each to 39,529.72 and 11,843.75 respectively. The declining sentiments are attributed to RBI’s changing its policy stance from ‘neutral’ to ‘accommodative’. “The market is not necessarily cheering the rate cut as it had already factored in and something more was expected,” says Naveen Kulkarni, head of research at Reliance Securities.

In its June 6 policy statement, RBI noted that the April policy meeting, GDP growth for FY20 was projected at 7.2% – in the range of 6.8-7.1% for H1:FY20 and 7.3-7.4% for H2:FY20 – with risks evenly balanced. However, data for Q4:FY19 indicate that domestic investment activity has weakened and overall demand has been weighed down partly by slowing exports, RBI’s monetary policy committee noted. “Weak global demand due to escalation in trade wars may further impact India’s exports and investment activity,” says RBI. “Further, private consumption, especially in rural areas, has weakened in recent months,” RBI further added. On the positives, RBI counted factors like political stability, high capacity utilisation, the uptick in business expectations in Q2, buoyant stock market conditions and higher financial flows to the commercial sector augur well for investment activity. Taking into consideration the factors and the impact of recent policy rate cuts, RBI revised GDP growth for FY20 downwards from 7.2% in the April policy to 7.0% – in the range of 6.4-6.7% for H1:FY20 and 7.2-7.5% for H2:FY20.

“The change in stance to ‘accommodative’ was a bit of a surprise,” says Suvodeep Rakshit, senior economist at Mumbai-based Kotak Institutional Equities. Rakshit, who is anticipating another 25 basis point cut in August policy meeting, is of the opinion that debt markets will take this as a significant positive move though most of the rate cut cycle is probably over. “The tone of the RBI policy was dovish and highlights the concerns on growth,” Rakshit adds. His August rate cut expectation is upon factoring in the benign inflation trajectory and the growing concerns on growth.

Welcoming the change of policy stance to ‘accommodative’, Garima Kapoor, economist at Mumbai-based Elara Capital says that “it will pave way for transmission to lending rates, which so far have been inadequate.” Kapoor is of the view that RBI’s monetary policy committee will cut rates by an additional 50 basis points through the year while continuing to fine tune liquidity support through a combination of open market operations (OMO) purchases, forex swap and cash reserve ratio (CRR) cut.

The other cause of stance change was the inflation scenario, primarily food inflation. RBI noted that the summer pick-up in vegetable prices has been sharper than expected, though this may be accompanied by a correspondingly larger reversal during autumn and winter.

According to RBI, more recent information also suggests a broad-based pick-up in prices in several food items. “This has imparted an upward bias to the near-term trajectory of food inflation,” says RBI. Secondly, a significant weakening of domestic and external demand conditions appear to have led to a sharp broad-based decline of 60 basis points in inflation excluding food and fuel in April; this has imparted a downward bias to the inflation trajectory for the rest of the year, says RBI. Thirdly, RBI notes that, crude prices have continued to be volatile.

However, its impact on consumer price inflation (CPI) has been muted so far due to incomplete pass-through. Fourthly, near-term inflation expectations of households have continued to moderate. Taking into consideration these factors, the impact of recent policy rate cuts and expectations of a normal monsoon in 2019, the path of CPI inflation is revised by RBI to 3.0-3.1% for H1:FY20 and to 3.4-3.7% for H2:FY20. “Risks around the baseline inflation trajectory emanate from uncertainties relating to the monsoon, unseasonal spikes in vegetable prices, international fuel prices and their pass-through to domestic prices, geo-political tensions, financial market volatility and the fiscal scenario,” RBI warned.

While markets are not cheering the RBI rate action, credit rating agency India Ratings and Research believes that the rate cut is unlikely to stimulate demand in the near term due to the absence of quick resonance in the financial market. Despite the RBI cutting policy rate by 50 basis points so far in 2019, banks have not adjusted their lending/deposit rate accordingly. “On the contrary, a number of banks have raised their deposit rates to mobilise funds,” India Ratings and Research notes. “More than the rate cut it is the transmission of the rate cut into the economy that has emerged as a bigger challenge,” the rating agency adds. The agency further notes that it is well known that the impact of the monetary policy on the Indian economy is felt with a significant lag, but the situation at the current juncture has become further complicated due to the ongoing crisis in both – the banking and the shadow banking sectors. “While banks are struggling with high NPAs, NBFCs are struggling with solvency issues leading to credit freeze.”

Given the challenges that the economy is facing at domestic as well as global front, the hat-trick on rate cut from RBI remains lacklustre.