Since early January, when the National Statistical Office (NSO) pegged India’s GDP to grow at 5% in FY20 compared to 6.8% in FY19, there was a consensus among the economy and market observers that Reserve Bank of India (RBI) governor Shaktikanta Das had a taxing time ahead.

While the six-member Monetary Policy Committee (MPC), chaired by Das, took a pause on rate action last December, it cited the then ensuing Union Budget to “provide better insight into further measures to be undertaken by the government and their impact on growth”.

Just two days after a (generally) not-so-forthcoming Union Budget, the MPC met again—from February 4 to 6—for the last time in this current fiscal. And, on expected lines, the MPC decided to keep the policy repo rate unchanged at 5.15%. The MPC also decided to continue with the ‘accommodative stance’ as long as it is necessary to revive growth while ensuring that inflation remains within the target, Das said.

At the customary media interaction after the policy announcement, the RBI governor acknowledged that the element of consistency on the rate and the policy stance was on ‘expected lines’. “But that should not be read as the MPC’s future action,” he warned. “MPC is guided by evolving developments and it is also important not to discount the RBI,” Das quickly added.

The MPC observed that the economy continues to be weak and the output gap remains negative. The MPC also acknowledged that the real GDP for FY20 turned out to be significantly lower than projected. In its October policy last year, the MPC had pegged GDP to grow at 6.1% in FY20 and 5.3% in Q2 and in the range of 6.6%-7.2% for the second half of the current fiscal year. According to the MPC, on the positive side, however, monetary policy easing since February 2019 and the measures initiated by the government over the last few months are expected to revive sentiment and spur domestic demand.

Taking these factors into consideration, the MPC revised downward the real GDP growth for FY20 from 6.1% in the October policy to 5.0%—4.9%-5.5% in the second half of the current financial year and 5.9%-6.3% for the first half of the next financial year (FY21). “While improved monetary transmission and a quick resolution of global trade tensions are possible upsides to growth projections, a delay in revival of domestic demand, a further slowdown in global economic activity, and geopolitical tensions are downside risks,” the MPC said.

On inflation, the MPC in December 2019 had projected CPI inflation at 5.1%-4.7% in the second half of the current financial year and 4.0%-3.8% for the first half of the next financial year. However, the actual inflation outcome for Q2, FY20, at 5.8% overshot projections by 70 basis points. Governor Das read out that CPI food inflation increased from 6.9%in October to 12.2% in December, primarily caused by a spike in onion prices due to unseasonal rains in October-November. “Excluding onions, food inflation would have been lower by 4.7% and the headline inflation by 2.1% in December,” he said. “In addition, inflation in several other food sub-groups such as milk, pulses, cereals, edible oils, eggs, meat, and fish also firmed up.”

Going forward, the MPC expects food inflation to soften from the high levels of December and the decline is expected to become more pronounced during Q4, FY20, as onion prices fall rapidly due to the arrival of late kharif and rabi harvests. Higher vegetable production, despite the early loss due to unseasonal rains, is also likely to have a salutary impact on food inflation. On the other hand, in the MPC’s view, the recent pick up in prices of non-vegetable food items—specifically milk—due to a rise in input costs, and pulses due to a shortfall in kharif production, are all likely to sustain.

These factors could impart some upward bias to overall food prices. Further, crude oil prices are likely to remain volatile due to unabating geopolitical tensions in West Asia on the one hand, and the uncertain global economic outlook on the other. Also, there has been an increase in input costs for services in recent months. However, subdued demand conditions, muted pricing power of corporates, and the correction in energy prices since the last week of January may limit the pass-through to selling prices. Taking these and similar other factors into consideration and also assuming a normal southwest monsoon in FY21, the MPC revised the CPI inflation projection upwards to 6.5% for Q4, FY20; 5.4%-5.0% for H1, FY21; and 3.2% for Q3, FY21.

Going forward, on interest rate action, in a base case scenario, Rahul Bajoria, senior India economist at Barclays Bank, expected the RBI to stay on hold through 2020. Bajoria thinks that the next window for modest rate cuts may open in H2, CY20, provided CPI inflation declines either quicker or in line with RBI’s projections. “We see the RBI remaining on hold in the April MPC meeting, although it may incrementally turn more dovish if growth stays mediocre and global commodity prices push down inflation faster than expected,” Bajoria said.

The other highlight of the MPC meeting was the introduction of long-term repo operations (LTROs) for improving monetary transmission. From the fortnight beginning on February 15, the RBI shall conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of ₹1 lakh crore at the policy repo rate.

Also, in a bid to incentivise the flow of bank credit to productive sectors having multiplier effects to support impulses of growth, the RBI has decided that scheduled commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as retail loans for automobiles, residential housing, and loans to micro, small, and medium enterprises (MSMEs), over and above the outstanding level of credit to these segments as at the end of the fortnight ended January 31, 2020, from their net demand and time liabilities (NDTL) for maintenance of cash reserve ratio (CRR). “This exemption will be available for incremental credit extended up to the fortnight ending July 31, 2020,” the RBI said.

According to Suvodeep Rakshit, senior economist, Kotak Institutional Equities, while the LTROs would lead to softening of market rates, RBI’s announcement of lower CRR maintenance through reduction in NDTL calculation to the extent of incremental retail lending for automobiles, residential housing and MSMEs could be positive for credit flow in the medium term. “Overall, the RBI has delivered positively towards growth and credit without deviating from the inflation-targeting framework,” Rakshit said. “Evolution of borrowing costs as well as credit flows need to be watched carefully.”

Calling the MPC meeting outcomes as Budget part 2, Jimeet Modi, founder and CEO of Samco Securities, said, “Although, interest rates have maintained a status quo but the RBI has smartly lubricated the slower-moving parts of the economy.”

Given that a no-rate-action policy was factored in, equity markets did not react much to the MPC's outcomes. At the day’s high of 41,405.43 points, the S&P BSE Sensex jumped 262.77 points from the previous day's close of 41,142.66 points.

The S&P BSE MidCap and S&P BSE SmallCap jumped 177.6 and 108.08 points each from the previous close to the day’s high on February 6. “As far as the stock markets are concerned, the outcome is more or less in line with expectations, and the markets will keep discounting other evolving development,” said Dhiraj Relli, managing director and CEO of HDFC Securities.

Going forward, inflation will be the RBI’s deciding factor on the rate action, while the RBI governor was vocal that the underlying theme of all the central bank decisions was financial stability.

Long Term Repo Operations

RBI stays ‘consistent’ on rate and policy stance