A man drinks tea as he walks past the Reserve Bank of India headquarter building in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)  

India Monetary Policy: MPC Keeps Rates On Hold But Shifts Stance To “Calibrated Tightening”

India’s monetary policy committee surprised markets by keeping interest rates unchanged, as it awaits for greater clarity on the evolving growth-inflation scenario in the economy. The six-member panel, however, changed its stance from 'neutral' to 'calibrated tightening', suggesting more rate hikes lie ahead.

Separately and importantly, in a measure which seemed to be aimed at curbing currency volatility, the Reserve Bank of India proposed a 'voluntary retention scheme' for foreign portfolio investors. The scheme offers increased investment flexibility to investors who choose to retain a portion of their investments in India for a time period of their choosing.

Key Takeaways

  • MPC keeps repo rate unchanged at 6.5 percent
  • MPC changes stance from neutral to 'calibrated tightening'
  • Repo rate kept unchanged by a 5-1 vote; Chetan Ghate voted for a rate hike
  • Stance changed by a vote of 5-1; Ravindra Dholakia voted for a neutral stance
  • RBI proposes voluntary retention route for FPIs in debt markets
  • Inflation projected at 3.9-4.5 percent in H2 and 4.8 percent in Q1 of financial year 2019-20
  • GDP growth seen at 7.4% in FY19 & 7.6% in FY20


In the press conference following the MPC decision announcement, RBI Governor Urjit Patel said “It is important to recognise that close to a decade-long extraordinary accommodation by systemic central banks is finally tapering off”.

This inevitable normalisation coupled with the risks stated above has resulted in several quantity and price adjustments in global financial markets. Global trade, according to latest WTO data, is losing pace possibly on account of ongoing tariff wars. In emerging markets, currency depreciation imposed additional upside inflation risk besides the contagion risks of a technical nature from specific EM episodes and geopolitical developments.
Urjit Patel, Governor, RBI

Rate Decision

The repo rate was left unchanged at 6.5 percent, following a three-day meet of the MPC which concluded on Friday. The reverse repo rate remains at 6.25 percent. Forty of 49 economists polled by Bloomberg News had expected a 25 basis point hike in the repo rate to 6.75 percent.

"The decision of the MPC is consistent with the stance of calibrated tightening of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth," the MPC's statement read.

The decision comes at a time when price pressures in the economy are moderate but upside risks to inflation have risen. Consumer price inflation stood at 3.69 percent in August, well within the MPC’s inflation target of 4 (+/-2) percent.

Since the last MPC meeting in August, the rupee has fallen 7 percent and Brent crude oil prices have risen more than 15 percent. Both these factors are expected to feed into inflation in the coming months. On Thursday, the government announced an intention to bring down auto fuel prices, partly through an excise duty cut. Economists expect the inflation impact of the decision to be marginal.

The MPC projects inflation at 3.9-4.5 percent in H2 of FY19 and 4.8 percent in Q1 of FY20.

Going forward, the outlook for inflation will be shaped by several factors, said the MPC in its statement. While food price inflation has been unusually benign, upside risks could emerge from fuel prices and depreciation in the currency, it added.

"The inflation outlook calls for a close vigil over the next few months, especially because the output gap has virtually closed and several upside risks persist," said the MPC.

GDP growth, meantime, is expected to moderate after hitting 8.2 percent in the first quarter of the current fiscal year. Manufacturing activity strengthened in September on new orders but services activity slumped, showed the Nikkei India PMI data released earlier this week.

The MPC’s projection for growth has been retained at 7.4 percent for the current year.

"Improving capacity utilisation, larger FDI inflows and increased financial resources to the corporate sector augur well for investment activity. However, both global and domestic financial conditions have tightened, which may dampen investment activity," said the MPC.

Market Reaction

The decision to maintain rates prompted the Rupee to decline to 74 versus the dollar from 73.60 levels earlier in the day. Bond prices rose and the 10 year government bond yield fell 16 basis points to 8 percent. Equity markets declined further with the Nifty falling below 10,400, down 60-80 points from before the policy announcement. Both benchmark equity indices closed with over 2 percent losses.

The MPC decision left market experts disappointed.

“This has clearly been much against my expectations,” said Amandeep Chopra, Group president and head of fixed income at UTI AMC. “Clearly this is not supportive of keeping rupee anchored and domestic rates market inline with inflation outlook,”he added in an interview with BloombergQuint.

Shubhada Rao, chief economist at Yes Bank said to BloombergQuint “A rate hike would have atleast calmed the market. On the action front, financial stability has overruled.”

“Its clearly surprising for me given the backdrop of macro-economic factors,” said Jaideep Iyer, strategy head at RBL Bank. Potentially the role of current financial stability would have played an equally important role in the decisions, he added.

Commenting on the change in stance to calibrated tightening Rao said “October and November were the most difficult months to come by and that's the time a lot of global issues will play out—a midterm election in U.S. and an OPEC meeting. But having said that, a 25 basis point hike today could have calmed the markets. The rupee wouldn't have been in a hurry to breach 74/$-mark.”

However, even a 50 basis point hike may have not been able to stem the fall in rupee for too long. There are some factors that aren’t directly under our control and what’s happened globally would eventually determine the rupee level. Perhaps, the central bank is keeping powder dry for when a deeper action is required.
Shubhada Rao, Chief Economist, Yes Bank

Now it is clear that we are headed only one way, Iyer said on the change in stance. “The pace is going to be is what is going to be debated.”

RBI is more focused on protecting the financial system and making sure that the NBFCs have enough liquidity than being obsessed about inflation, said market expert Saurabh Mukherjea to BloombergQuint.

He added this would prompt further currency weakening.

“The rupee seems headed for 75, given that RBI is focusing on flushing the system with liquidity and protecting the financial systems rather than protecting the currency.” 
Saurabh Mukherjea, Marcellus Investment Managers

“This is a risky move by the RBI since the market was positioned for a rate hike, purely as a rupee defence,” said Abheek Barua, chief economist at HDFC Bank in an emailed statement.

In its absence currency and asset markets could see sharper corrections. A narrow focus on inflation targets perhaps not desirable in the middle of a financial crisis. The change in stance suggests that the rate hike could still come in the coming months.
Abheek Barua, Chief Economist, HDFC Bank