RBI Turns Dovish With 25 Basis Point Rate Cut
The Reserve Bank of India (RBI) on Tuesday cut its benchmark interest rate by 25 basis points, citing a decline in inflation in the economy. All six members of the monetary policy committee voted in favour of the rate cut, the RBI said.
The decision, the first to be taken by the monetary policy committee, is not out of line with market expectations. Four of ten economists polled by BloombergQuint had forecast a 25 basis point repo rate cut while others had suggested that the RBI may wait until December to cut rates.
Commenting on the outlook for the economy in its monetary policy report, the RBI said while the inflation outlook has improved, it requires close monitoring.
The inflation outlook for 2016-17 has improved, but beyond, close vigilance is required to achieve the prospects of reaching 4 percent i.e., the centre of the target band.Reserve Bank of India statement
“Robust consumption brightens the outlook for real gross value added (GVA) in 2016-17, but muted private investment and weak global demand may restrain the pace of growth in 2017-18,” it added.
Following this cut, the benchmark repo rate stands reduced to 6.25 percent from 6.50 percent earlier. The central bank has now cut rates by 175 basis points since the start of 2015 when it started to ease monetary policy in response to declining inflation.
In the post-policy press conference, Michael Patra, executive director at the RBI said that the central bank may be comfortable with a real rate of 1.25 percent compared to the 1.5-2 percent band that the RBI had earlier said it would like to maintain.
Economists saw both the RBI’s action and its statements as dovish.
“ A unanimous vote for rate cut and acting in accordance with the inflation data suggests that one more 25bps rate cut could be in the offing by year end,” said Abheek Barua, chief economist at HDFC Bank in a report.
Outlook For Inflation
The central bank expects inflation at close to 5 percent by the fourth quarter of 2016-17 with some upside risks seen to that forecast.
The RBI, however, appeared less confident about the inflation trajectory in 2017-18 and said the direct and indirect impact of an increase in House Rent Allowance as part of the Seventh Pay Commission awards may require a tightening of monetary stance.
The RBI further added that the implementation of the Goods and Services Tax (GST) will also impact the trajectory of inflation. A standard rate of 18 percent will have a minimal impact on inflation, said the RBI. A standard rate of 22 percent could impact inflation by 0.3-0.7 percentage point.
Consumer price inflation, which is now the nominal anchor for monetary policy, fell to 5.05 percent in August compared to 6.07 percent in July. The decline was led by lower prices of vegetables and a decline in the inflation rate for the pulses category. Most economists expect headline inflation to remain in check following a good monsoon. JPMorgan expects retail inflation to fall to 4.5 percent in September.
Indirect impact arising out of aggregate demand may require tightening of monetary policy stance to ensure inflationary pressures do not generalised and entrenched into expectations.Reserve Bank of India statement
Outlook For Growth
Growth indicators, meantime, remain volatile. The Index of Industrial Production fell 2.4 percent in July. The Nikkei Markit India Manufacturing Purchasing Managers' Index (PMI), a gauge of manufacturing performance, fell to 52.1 in September from 52.6 in August, indicating that growth in the sector lost some momentum.
“Aggregate demand slowed down in the first quarter of 2016-17, restrained by weak investment, but consumption spending is gradually improving. Aggregate supply conditions are poised to receive a strong boost from a re-invigoration of agriculture with some support from services, but industrial activity remains subdued,” said the RBI. It added that the output gap remains negative but is closing slowly.
While announcing another rate cut, the RBI remains concerned about the incomplete transmission of monetary policy.
In its monetary policy report, the RBI noted that interest rates in the bond market and the commercial paper market have fallen but bank lending rates have not seen a drop. This may necessitate another review of the marginal cost lending rate (MCLR) framework.
“Structural and cyclical factors impeding transmission to bank lending rates, particularly stressed balance sheets of banks and sluggish credit growth, may require a review of the MCLR implementation by banks, given the context of significant softening of long-term yields,” said the RBI.
“In this scenario, the Reserve Bank would continue to manage liquidity proactively and consistent with the stance of monetary policy, while taking timely and appropriate measures to insulate the system from shocks,” it added.
Tuesday’s decision was taken after a two-day meeting of the Monetary Policy Committee, which comprises of three RBI representatives and three external members. The RBI is represented by governor Patel, deputy governor R Gandhi and executive director Michael Patra. The three external members include academicians Chetan Ghate, Ravindra Dholakia and Pami Dua.
The minutes of the MPC meeting will be released with a gap of two weeks.
The rate cut reflects a wide range of opinions, and will boost liquidity and sentiment in the market, said Finance Secretary Ashok Lavasa. The cut is in line with economic data and the inflation target, he added.
Indian equities gained for a third straight day buoyed by the rate cut. The S&P BSE Sensex gained 0.3 percent to 28,334 while the NSE Nifty too advanced 0.4 percent to close above the 8,750 mark at 8,769. The rupee too extended its gains. The rupee closed at 66.46 against the dollar, up 0.18 percent from previous close. The yield on the benchmark 10-year bond fell to 6.73 percent compared to its previous close of 6.77 percent.