Monetary Policy: MPC Cuts Benchmark Rate, Maintains Stance
Shaktikanta Das, governor of the Reserve Bank of India (RBI), left arrives at a news conference in Mumbai, India, on Thursday, Feb. 7, 2019. (Photographer: Dhiraj Singh/Bloomberg)

Monetary Policy: MPC Cuts Benchmark Rate, Maintains Stance

India’s Monetary Policy Committee on Thursday voted to cut its benchmark interest rate for a second consecutive meeting, amidst rising concerns over economic growth. The monetary policy stance has been maintained at 'neutral', giving the committee room to move in either direction based on incoming data.

The MPC voted 4-2 to cut the repo rate by 25 basis points to 6 percent. The reverse repo rate stands reduced to 5.75 percent from 6 percent earlier. RBI Deputy Governor Viral Acharya and committee member Chetan Ghate voted for a status quo in rates. Five of six members voted to keep the stance unchanged at neutral, while committee member Ravindra Dholakia voted to change the stance to accommodative.

"These decisions are 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," said the MPC in its resolution.

Key Takeaways

  • MPC votes 4-2 to cut repo rate by 25 bps to 6 percent
  • MPC votes 5-1 to keep stance unchanged at neutral
  • RBI expects GDP growth at 7.2 percent in FY20 compared to 7 percent in FY19
  • RBI expects CPI inflation at 2.9-3.0 percent in H1:2019-20 and 3.5-3.8 percent in H2:2019-20, with risks broadly balanced
  • RBI allows banks to use an additional 2 percent from SLR bucket for purpose of Liquidity Coverage Ratio
  • RBI defers external benchmarking of retail loans pending further consultations
Monetary Policy: MPC Cuts Benchmark Rate, Maintains Stance

The decision to cut rates was in line with expectations. Forty one of 43 economists polled by Bloomberg expected a 25 basis point rate cut. The committee had cut interest rates by a similar quantum at its February meet. With a second rate cut, the MPC has reversed the hike in rates announced during the course of 2018.

The MPC was guided by benign headline inflation and weakening economic growth.

The RBI expects the economy to grow at 7.2 percent in FY20 compared to 7 percent in FY19. It sees headwinds to growth emerging from the global economy, which could accentuate recent softness in momentum in the domestic economy.

The MPC notes that the output gap remains negative and the domestic economy is facing headwinds, especially on the global front. The need is to strengthen domestic growth impulses by spurring private investment which has remained sluggish.
MPC Statement

High frequency indicators such as auto sales have suggested weaker demand conditions, while others like bank credit growth point to a reasonable level of stability in the economy. In recent weeks, global growth concerns have added to domestic concerns, leading to calls for lower interest rates.

Meanwhile, inflation remains within the MPC's mandated range of 4 (+/-2) percent.

"The path of CPI inflation is revised downwards to 2.4 percent in Q4:2018-19, 2.9-3.0 percent in H1:2019-20 and 3.5-3.8 percent in H2:2019-20, with risks broadly balanced," the MPC said.

CPI inflation stood at 2.57 percent in February compared to a revised 1.97 percent in January 2019. While some MPC members have expressed concern about high core inflation, RBI governor Shaktikanta Das has asserted that the committee’s legal mandate is to target headline inflation.

The MPC, in its assessment of inflation, said that food prices remain low and fuel inflation has declined further. In addition, core inflation in February too was lower than expected. "Inflation expectations of households as well as input and output price expectations of producers polled in the Reserve Bank’s surveys have further moderated," the MPC said. It added that a recent slowdown in economic momentum may also have a bearing on the inflation outlook.

Right now, the focus is more on growth, because inflation risk, despite expectation on food inflation picking up, is still within control, said DK Joshi, chief economist at CRISIL to BloombergQuint after the MPC resolution was announced.

I would expect more rate cuts going ahead, if this is the trajectory for inflation because I think this is pretty benign.
DK Joshi, Chief Economist, CRISIL

The policy decision is along expected lines, said Neeraj Gambhir, managing partner at Incipia Advisors. He pointed to the MPC’s comments on the negative output gap and headwinds facing the domestic economy as indicative of further rate cuts.

There is a need to strengthen domestic growth by spurring private investment which has remained sluggish. This is actually a very dovish statement in terms of growth and inflation. I clearly expect more rate cuts to happen.
Neeraj Gambhir, Managing Partner, Incipia Advisors

We expect further rate action post budget, said Prashant Kumar, chief financial officer at State Bank of India. He also welcomed the RBI’s decision to permit 2 percent excess SLR towards LCR. “This would definitely release more money for the banks to lend.”

10-year bond yields spiked right after the MPC announcement but have since settled at 7.31 percent. Equity markets fell right after the MPC announcement, especially Nifty Bank index that declined some 200 points. But both headline indices and the Nifty Bank have recovered since.

Monetary Policy: MPC Cuts Benchmark Rate, Maintains Stance

Developmental Policies

MEASURE: Banks permitted to use an additional 2 percent of securities under SLR for purpose of Liquidity Coverage Ratio
IMPACT: Liquidity relief for banks running high credit-deposit ratios

MEASURE: Not necessary to activate counter-cyclical buffer at this stage
IMPACT: Saves banks from making additional provisions

MEASURE: External benchmarking of retail floating rate loans deferred
IMPACT: Continued delay in improving transmission of monetary policy

MEASURE: Committee set up India's housing finance securitisation market
IMPACT: May propose measures to develop market further and reduce role of 'direct assignment'

MEASURE: Committee set up for development of secondary market for corporate loans
IMPACT: May propose measures to increase liquidity in these securities

Monetary Policy Report On Inflation

  • CPI inflation projected at 2.9 percent in Q1; 3 percent in Q2; 3.5 percent in Q3; 3.8 percent in Q4
  • CPI inflation expected to move up from recent lows but remain below target.

Monetary Policy Report On Growth

  • Real GDP growth projected to improve from 7 percent in FY19 to 7.2 percent in FY20
  • Private consumption likely to remain its mainstay and investment activity expected to remain strong
  • Urban consumption may get support from election spending, tax exemptions and strong flow of personal loans
  • Rural consumption may get support from farm income schemes, loan waivers and thrust on rural infrastructure
  • Global economic activity and trade have been shedding momentum and downside risks have increased

Monetary Policy Report On Flow Of Financial Resources

  • Flow of financial resources from banks, non-banks increased significantly in FY19
  • Relative share of bank, non-bank resources shifts towards banks.

Monetary Policy Report On Liquidity

  • Liquidity operations would continue to focus on aligning WACR (weighted average call rate) with policy rate
  • Adequate and swift monetary policy transmission remains a policy challenge for RBI

“The RBI governor has assured that they will do everything they can to replenish liquidity and that is reassuring. But the government has already come out with the borrowing programme and there could be some apprehensions and volatility in bond yields because of the size of the borrowing,” said SBI’s Kumar.

Watch live coverage of the MPC’s decision here:

Also read: MPC’s Dilemma: How Deep Is The Slowdown?

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