RBI governor Shaktikanta Das-headed Monetary Policy Committee (MPC) sprung a surprise when it unanimously voted to keep the benchmark repo and reverse repo rates unchanged at 5.15% and 4.9% respectively. All six members of the panel voted to continue with the accommodative stance “as long as it is necessary to revive growth, while ensuring that inflation remains within the target”.
Why the MPC voted against the dominant consensus for a 25 basis points rate cut can be gauged from its cautious reading of the trajectory of inflation in the coming months. The central bank has raised its inflation estimate to 5.1% -4.7% for the second half of FY20 and 4%-3.8% for the first half of FY21. Heightened concerns around inflation mainly stem from rising vegetable prices and incipient price pressures seen in other food items like milk, pulses, and sugar. Also, the government is likely to announce fiscal measures to boost demand in the upcoming budget.
In this light, the RBI said it was "prudent to carefully monitor incoming data to gain clarity on the inflation outlook. Similarly, the forthcoming union budget will provide better insight into further measures to be undertaken by the government and their impact on growth."
While the MPC's main mandate is to rein in inflation at 4% within a band of +/- 2% in the medium term, the floundering economy was hoping for a shot in the arm in the form of a rate cut to revive the growth cycle. More so, because the RBI has cut its growth target to 5% from 6.1% for FY20, and 5.9%-6.3% for the first half of FY21.
"While improved monetary transmission and a quick resolution of global trade tensions are possible upsides to growth projections, a delay in the revival of domestic demand, a further slowdown in global economic activity and geo-political tensions are downside risks," the RBI said.
However, Das reaffirmed the RBI's commitment to work with the government to revive the growth cycle. "The government and the RBI have good coordination, and so far it has been going well. We are working in a coordinated manner and are committed to growth revival," he said.
It is important to note that the MPC has not slammed the brakes on rate cuts, yet. "The MPC recognises that there is monetary policy space for future action. However, given the evolving growth-inflation dynamics, the MPC felt it appropriate to take a pause at this juncture," the central bank said in its policy document.
At 5.1% the benchmark repo rate is the lowest in nine years. The central bank has cut rates to the tune of 135 basis points this year but the one-year MCLR rate has come down by 49 basis points: indicating that the transmission of rate cuts into lending rates has been inadequate. In this context, the RBI governor said, "The timing of the rate cut is important to optimise the impact." He also pointed out that more time was needed to allow the recent measures implemented by the government to play out.
The fifth bi-monthly monetary policy outcome disappointed Dalal Street and India Inc. Growth has faltered in the past few quarters. It declined to a six-year low of 4.5% while nominal growth hit a record low of 6.1% in the September quarter. Even though the government has announced a slew of pro-reform measures to boost economic activity over the past few months, these measures are yet to trickle down for a meaningful impact. The corporate sector was largely banking on a 25 basis points rate cut to help kickstart the investment cycle.
The stock markets ended a day of volatile trading and slipped into the red after the RBI credit policy was unveiled. S&P BSE Sensex lost 70.70 points to close at 40,779.59 points. The day's casualties include the banking and automobile sectors, which are rate-sensitive. Metal stocks were also under pressure, while IT stocks were among the top gainers in trade on Thursday.
Many leading economists and market watchers say the focus on achieving a 4% inflation target may signal the end of rate cuts for the next year as food prices are showing an upward trend.
Here are some views and opinions from the industry and experts on the RBI's latest move:
“The RBI decision for a status quo though an unanticipated policy surprise is the most appropriate as monetary policy works with a lag. The lowering of the GDP growth for FY20 and FY21 reflects continued growth conundrums and a slow recovery." – Rajnish Kumar, chairman, State Bank of India.
“RBI surprised the markets with a pause after 5 consecutive rate cuts...The accommodative policy stance assures of a supportive interest rate regime and durable liquidity. The transmission of previous rate cuts has been passed on efficiently as reflected in the bond markets. Further, the government’s on-going initiatives will help revive the economy.” – Rajiv Sabharwal, MD and CEO, Tata Capital.
“We expect some tightening in bond yields in response to this surprise. Given the paucity of loan demand, banks are likely to chase assets and the transmission process could gain traction. However, the flight to safety and large risk premiums for risky borrowers will persist." – Abheek Barua, chief economist, HDFC Bank.
"We believe that the RBI would wait for the Union Budget to get clarity on fiscal slippages/fiscal stimulus before taking further monetary action. If the growth continues to surprise on the downside and inflation remains within the comfort zone of RBI, there is a possibility of another rate cut. Meanwhile, the focus of MPC / RBI would be on effective transmission of rate cuts, improvement in credit flow, and lower term spreads at longer end and lower-rated corporate bonds.” – Rupen Rajguru, executive director and head of equity investment and strategy, Julius Baer India.
"The December policy highlighted that inflation remains a priority. While the RBI has kept the option of further rate cuts, it will depend clearly on the inflation prints, especially January and February inflation outturns. As of now, we do not see a rationale for a rate cut in February policy based on the current thought process of the MPC.” – Suvodeep Rakshit, vice president and senior economist, Kotak Institutional Equities.
"This is tantamount to an implicit rate hike - premature and unwarranted, in our opinion, because this is a demand-side reaction to supply-side retail inflation. Growth is left unaddressed. At least the saving grace is that no ammunition was expended on piecemeal measures. We still hope that the growth priority prevails and a substantial easing is brought about in the next policy cycle." – Ranjan Chakravarty, economist and product strategist, Metropolitan Stock Exchange.
“The industry expectation was that slowing economic growth would take precedence in RBI’s policy decision. Hence, RBI’s decision to not lower interest rate has come as a surprise and a bit of a disappointment to the industry. Lower interest rate would have helped push up credit demand and investment in the economy, aiding overall economic growth. It would have provided much required reprieve to some ailing sectors like real estate and auto.” – Shishir Baijal, chairman and managing director, Knight Frank India.