India’s MPC Cuts Repo Rate To 4% In Second Emergency Move
The RBI logo is displayed outside its headquarters in Mumbai, on March 3, 2020. (Photographer: Kanishka Sonthali/Bloomberg)

India’s MPC Cuts Repo Rate To 4% In Second Emergency Move

India’s Monetary Policy Committee cut interest rates following an emergency meeting citing the “severe” impact of the Covid-19 crisis on the Indian economy. This is the second emergency rate cut since the crisis hit Indian shores in March.

Following the MPC’s review:

  • The repo rate stands reduced to 4 percent from 4.4 percent earlier.
  • The reverse repo rate has been reduced to 3.35 compared to 3.75 percent.
  • All MPC members voted for a rate cut but the quantum of cut of 40 basis points was approved by a vote of 5-1.

The MPC also decided to continue with the accommodative stance “as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target,” it said in its statement.

India has now cut the benchmark repo rate by 115 basis points since the Covid crisis began, bringing it down to record lows. The reverse repo rate, at 3.35 percent, is marginally above the all-time low of 3.25 percent.

India’s MPC Cuts Repo Rate To 4% In Second Emergency Move

FY21 Growth Set To Be ‘Negative’

In its statement, the MPC said that the macroeconomic impact of the pandemic is turning out to be more severe than initially anticipated, and various sectors of the economy are experiencing acute stress.

The committee stayed away from giving projections for growth in FY21. However, Das, in his statement said that real GDP growth in FY21 is expected to remain in the negative territory.. Much will depend on the pace at which the Covid-19 curve is flattened, he added.

Private forecasters have already pegged down FY21 real GDP growth forecasts. Goldman Sachs expects the economy to contract by 5 percent in real terms this year, making it first annual contraction in nearly four decades.

According to the MPC’s statement, economic activity may remain subdued even in the second quarter of the current financial year due to social distancing measures and the temporary shortage of labour. “Recovery in economic activity is expected to begin in Q3 and gain momentum in Q4 as supply lines are gradually restored to normalcy and demand gradually revives,” it added.

The inflation outlook, meanwhile, is highly uncertain, Das said. Headline inflation may remain firm in the first half of 2020 due to supply disruptions, but is expected to ease in the second half. The guidance is directional, he added. The MPC did not provide forecasts for inflation either.

With the inflation outlook remaining benign as lockdown-related supply disruptions are mended, the policy space to address growth concerns needs to be used now rather than later to support the economy, even while maintaining headroom to back up the revival of activity when it takes hold.
MPC Statement

Also read: Bonds Rally in India After RBI Announces Emergency Rate Cut

Front-Loading Rate Cuts

Saugata Bhattacharya, chief economist at Axis Bank said that given the confluence of problems, it made sense for the MPC to cut rates now rather than wait. The rate cut will allow banks to immediately bring down lending rates, he said. Beyond the interest rate cuts, the full set of measures announced by the RBI is intended to ease cash flow problems being faced by businesses.

Room for further rate reductions from here on may be small, Bhattacharya said.

Rahul Bajoria, chief India economist at Barclays said the emergency rate cut shows policy makers are “nimble and calibrated” in response to incoming data. While interest rate cuts take two to three quarters to transmit through the system, a cut in policy rates is important from a signalling point of view, he said. Bajoria, however, added that the front-loading of the rate cutting cycle does not necessarily indicate a deeper rate cutting cycle.

Jayesh Mehta, country treasurer at Bank of America, termed the move as ‘surprisingly positive,’ adding that the markets were not expecting an emergency rate cut. Commenting on the transmission of the rate cuts, Mehta said that as government sovereign yields keep coming down, other credit instruments will start to look more attractive.

Bond markets responded cautiously to the MPC’s decision, with yields dropping by just 4 basis points to 5.73 percent on the new 2020 benchmark bond. Equity markets traded negative with benchmark indices trading lower by over half a percent at mid-day.

Suyash Choudhary, head of fixed income at IDFC Mutual Fund sees diminishing utility of policy rate cuts due to the risk aversion in the system.

Traditional easing is now rapidly diminishing in utility and effectiveness as it is not able to solve for either the substantial steepness of the curve (reflecting reluctance to take on duration risk) or the higher levels of spreads on lower rated issuers (reflecting credit risk aversion). Both are reflective of inadequate availability of deployable risk capital in the system.
Suyash Choudhary, Head - Fixed Income, IDFC AMC

Also read: How Low Can Interest Rates Go In India?

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