Shaktikanta Das interacts with the media at the RBI office in New Delhi. (Source: PTI)

Monetary Policy: MPC Cuts Rates By 25 Basis Points, Changes Policy Stance

India’s Monetary Policy Committee voted to cut interest rates by another 25 basis points, citing significant weakness in growth impulses. Paring its growth estimate for 2019-20 to 7 percent from 7.2 percent earlier, the committee also changed its stance from 'neutral' to 'accommodative', suggesting it stands ready to cut rates further should economic conditions warrant it.

Following a three-day meet, the MPC decided to reduce its benchmark repo rate to 5.75 percent from the current 6 percent. The reverse repo rate stands adjusted to 5.50 percent. The MPC, headed by Shaktikanta Das who took over as Reserve Bank of India governor in December 2018, has cut rates by 75 basis points so far in 2019.

Unlike the last two policy decisions, this one was unanimous, with all six MPC members voting for a cut in rates and a change in stance.

"The MPC notes that growth impulses have weakened significantly as reflected in a further widening of the output gap compared to the April 2019 policy. A sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern," the MPC statement said.

Meanwhile inflation remains below the mandated target.

Hence, there is scope for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular, reinvigorate private investment activity, while remaining consistent with its flexible inflation targeting mandate.
MPC Statement

A Bloomberg poll showed that 27 of 36 economists polled had expected a 25 basis point cut. Seven expected a status quo, while 1 economist expected a 50 basis point cut. One economist had forecast a 35 basis point rate cut.

Monetary Policy: MPC Cuts Rates By 25 Basis Points, Changes Policy Stance

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MPC Outlook On Growth, Inflation

The rate cut followed a further weakness in growth indicators.

India’s GDP growth fell to a 20-quarter low of 5.8 percent in the January-March 2019 quarter, showed government data released on May 31. Consumption growth fell to 7.2 percent year-on-year, while investment growth slipped sharply to 3.8 percent.

Apart from domestic concerns, ranging from weakness in rural demand and reduced flow of finance from non-bank lenders, global growth concerns have also deepened in recent weeks.

On the back of these concerns the MPC has cut its FY20 growth forecast to 7 percent from 7.2 percent earlier.

Data for Q4 2018-19 indicate that domestic investment activity has weakened and overall demand has been weighed down partly by slowing exports. Weak global demand due to escalation in trade wars may further impact India’s exports and investment activity. Further, private consumption, especially in rural areas, has weakened in recent months.
MPC Statement

Meanwhile, inflation remains in check, allowing the MPC room to cut rates.

Headline CPI inflation has risen to 2.9 percent due to a reversal in food inflation. However, it remains within the band of 4 (+/-2) percent.

The MPC noted that the pick-up in food prices has been sharper than expected. This has imparted an upward bias to food inflation. However, weakening domestic demand has led to a broad based decline in core inflation. Inflation expectations have also moderated.

As such, the MPC now sees CPI inflation at 3-3.1 percent in H1 FY20 and at 3.4-3.7 percent in H2 FY20. In April, the RBI had said it expects CPI inflation at 2.9-3.0 percent in the first half of FY20 and 3.5-3.8 percent in the second half.

RBI Review Of Liquidity Framework

Giving in to demands from market participants for a review of the existing liquidity framework, the RBI said it has decided to set up an internal working group. The group will submit its report by July 2018.

Its mandate will include a review of the current liquidity framework, communication of objectives, quantitative measures and toolkit of liquidity.

Market Reaction

The 10 year bond yield fell to 6.88 percent after the rate and stance change, from its pre-policy level of 6.99 percent. Key equity indices pared losses on the rate cut announcement, but the Sensex, Nifty Fifty and Nifty Bank continued to trade in the red. The rupee continued to trade at 69.32-69.34 levels to the dollar.

“It's a glass half empty, half full. Half full for the bond markets, half empty for the equity markets,” said Mihir Vora, CIO at Max Life Insurance, on the market reaction to the MPC announcement.

Monetary Policy: MPC Cuts Rates By 25 Basis Points, Changes Policy Stance

Also read: Bonds Rally in India After Central Bank Signals More Rate Cuts

The unanimous vote for a rate cut reflects the gravity of the situation in terms of the way the economy is going, said fixed income expert Manish Wadhawan. “The change of stance gives a longer horizon for lower rates to sustain and should be definitely helpful,” he added.

DK Joshi, chief economist at CRISIL, said he expects one more 25 bps cut in 2019 since the MPC doesn’t see risks to inflation despite food prices going up.

Unless there is anything adverse, we are penciling in another 25 bps rate cut this calendar year. The monetary policy is becoming more and more growth-supportive and the consensus on the MPC also indicates that growth has now become a greater concern and the output gap is also pointing towards an accommodative stance right now.  
DK Joshi, Chief Economist, CRISIL

“Although the RBI has already delivered the 75 basis points of cumulative rate cuts that we projected in our baseline scenario, we believe the shift to an “accommodative” stance could hint at further easing ahead,” said Sonal Varma, chief India economist at Nomura Global Market Research.

Pranjul Bhandari, chief economist at HSBC India shared that view. “With its 'accommodative' stance, we expect the RBI to remain supportive, maintaining liquidity at a slight surplus over the next few months. On the margin, this could aid transmission of policy rate cuts,” she wrote in her note.

Dhananjay Sinha, head of strategy and chief economist at IDFC Securities said that supportive fiscal and monetary policies will help consumption. “With the focus shifting towards the fiscal stimulus from the upcoming budget, along with an accommodative monetary policy, in our view, should boost consumption demand.” A revival in private capex, though, is unlikely immediately, Sinha said.