MPC Meet: Repo, Reverse Repo Rate Left Unchanged
RBI Governor Shaktikanta Das at his office in Mumbai. (Photographer: Kanishka Sonthali/Bloomberg)

MPC Meet: Repo, Reverse Repo Rate Left Unchanged

India’s Monetary Policy Committee voted to leave policy rates unchanged after two emergency cuts even though the economy faces a sharp contraction due to the Covid-19 virus.

The committee voted unanimously to keep the repo rate unchanged at 4%. It maintained an accommodative stance on monetary policy. The Reserve Bank of India, which controls the reverse repo rate, separately decided to keep that unchanged at 3.35%.

The MPC noted that economic activity had started to recover but fresh infections have led to a leveling-off of the pick-up in activity, RBI Governor Shaktikanta Das said while announcing the policy.

The MPC was of the view that supply-chain disruptions persist and have implications for both food and non-food inflation. The MPC expects headline inflation to remain elevated in Q2 and sees it easing in the second half. As regards with growth, real GDP growth in the first half of the year will remain in contraction. For the full year too, real GDP growth is likely to remain in contraction too.

The MPC noted that in an environment of unprecedented stress, supporting recovery of the economy assumes primacy in the conduct of monetary policy. While space for further monetary policy action is available,it is important to use it judiciously to maximise the beneficial effects for underlying economic activity.
MPC Statement

Growth Outlook

The Indian economy is expected to contract for the first time in over four decades due to the Covid-19 outbreak. A rebound in economic activity after the lifting of nationwide restrictions has been followed by a flattening of the recovery curve as states have enforced localised lockdowns.

  • The RBI acknowledged that several high-frequency indicators have levelled off due to lockdowns imposed in states to curb the spread of the virus.
  • According to the MPC’s assessment, the recovery of the rural economy is expected to be robust, buoyed by the progress in kharif sowing.
  • Manufacturing firms expect domestic demand to recover gradually from Q2, but consumer confidence turned more pessimistic in July relative to the preceding round of the Reserve Bank’s survey.

The MPC and RBI stayed away from detailing their forecasts for growth but said that real GDP is likely to contract in FY21.

Taking into consideration the above factors, real GDP growth in the first half of the year is estimated to remain in the contraction zone. For the year 2020-21 as a whole, real GDP growth is also estimated to be negative. An early containment of the Covid-19 pandemic may impart an upside to the outlook. A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks.
MPC Statement

Forecasters have recently cut estimates for FY21 growth. Rating agency ICRA now estimates GDP to contract by 9.5%, from its earlier forecast of a 5% contraction. Bank of America Securities expects GDP to contract by 6% this year. JPMorgan sees a contraction of 6.5% in GDP.

Inflation Outlook

The MPC, which met for the last time in its first four-year cycle, noted the supply-side pressures visible in inflation. The MPC is conscious of its medium-term inflation target., the resolution said.

According to the MPC’s analysis, the headline inflation prints of April-May 2020 are obscured by the spike in food prices and cost-push pressures.

  • The committee expects a more favourable food inflation outlook to emerge as the bumper rabi harvest eases prices of cereals. “Nonetheless, upside risks to food prices remain.”
  • The abatement of price pressure in key vegetables is delayed and remains contingent upon normalisation of supplies. Protein-based food items could also emerge as a pressure point.
  • Higher domestic taxes on petroleum products have resulted in elevated domestic pump prices and will impart broad-based cost push pressures going forward.
  • Taking into consideration all these factors, the MPC expects headline inflation to remain elevated in Q2 FY21, but it's likely to ease in the second half aided by favourable base effects.
Given the uncertainty surrounding the inflation outlook and extremely weak state of the economy in the midst of an unprecedented shock from the ongoing pandemic, the MPC decided to keep the policy rate on hold, while remaining watchful for a durable reduction in inflation to use available space to support the revival of the economy.
MPC Statement

Will There Be More Rate Cuts?

The MPC may take a pause but growth will remain a priority, said Jayesh Mehta, managing director and country treasurer at Bank of America. He expects space for another 50 basis points in rate cuts. But this would be used judiciously and would also depend on what the government does, Mehta said.

Aditi Nayar, prinicipal economist at ICRA, expects only one more rate cut in the third quarter of the ongoing financial year, the timing of which will be guided by how quickly the headline CPI inflation reverts to 4%.

Agreed Rahul Bajoria, chief India economist at Barclays. He expects one more cut to acknowledge the MPC’s accommodative policy stance, but this may only materialise in the fourth quarter of 2020-21, taking the terminal repo rate to 3.75%. “Today’s lack of a rate cut from the RBI, similar to the December 2019 MPC meeting, once again establishes the primacy of inflation over growth, no matter what the extent of the economic downturn,” said Bajoria.

Saugata Bhattacharya, chief economist at Axis Bank also said that India is effectively close to its lower bound on rates. "We are already near India’s effective lower bound," he said, adding there maybe space for just another 15-25 basis points in rate cuts but not more than that. “In a deposit-centric financial structure, the stability of the system depends on the accretion of deposits. We have already seen fixed deposit rates come down significantly.” There is also a fear of foreign outflows if inflation differentials come down, he said.

The bottom line is that the room to use conventional monetary policy tools is beginning to compress, Bhattacharya said.

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