RBI cuts policy rate and FY20 growth forecast

Faced with an economic slowdown driven by weak consumer sentiment and tepid consumption demand, the Reserve Bank of India on Friday cut its policy repo rate by 25 basis points, or a quarter of 1 percentage point.

The fifth consecutive rate cut in the past eight months came with an assurance of an accommodative stance till growth revives, suggesting more cuts down the line, but there was also a bit of downbeat news.

The central bank sharply cut the GDP growth projection for FY2020 from 6.9 per cent (made in its August policy statement) to 6.1 per cent.

Read RBI's fourth bi-monthly monetary policy statement

The stock markets took the news badly. with the bellwether Sensex sliding 434 points on a day of wild gyrations; The Nifty, too, plunged 139 points.

The repo rate reduction is aimed at supplementing the government’s recent measures, including the corporate tax rate cut, to revive economic activity.

With this, the policy repo rate stands at 5.15 per cent, against 5.40 per cent earlier. In the previous bi-monthly monetary policy review, the rate was cut by an ‘unconventional’ 35 bps.

While cutting the GDP growth projection, the RBI reasoned that domestic demand conditions remained weak and export prospects were being impacted by slowing global growth and continuing trade tensions.

Five of the six members on the Monetary Policy Committee (MPC) voted for the 25 bps cut. The lone holdout was Ravindra Dholakia, former Professor, Indian Institute of Management, Ahmedabad, who favoured a 40 bps reduction. All six members voted to continue with the accommodative stance.

The repo rate is the interest rate at which banks borrow funds from the RBI to overcome short-term liquidity mismatches. One basis point is equal to one-hundredth of a percentage point.

“We have cut the policy rate by 135 bps (from February till date),” said Governor Shaktikanta Das at the press meet after the release of the MPC resolution. “It takes time for the impact to filter through to the real economy, so we will have to see the impact of all these policy rate cuts.” He added: “We will have to also see how the government’s fiscal measures over the last few months will impact the real economy. At this point of time 25 bps was the call that the MPC took.”

The assurance of an accommodative stance for as long as is necessary was intended to give some kind of forward guidance that till growth revives, the RBI will remain in an accommodative mode.

Deposit, lending rates to fall

With banks linking floating loans for retail and micro and small enterprise segments to the repo rate with effect from October 1, 2019, lending rates for new borrowers in these two segments are expected to come down further in the ongoing festival season. In order to protect margins, banks may also cut deposit rates.

Padmaja Chunduru, Managing Director & CEO, Indian Bank, believes that the transmission (to lending rates) of monetary policy rate changes will be faster now.

As banks have already introduced Repo-linked Retail and MSE products, the rate cuts will be passed on to borrowers. The rate cut will boost market sentiments during the festival season, she added.

The MPC noted that the negative output gap (when actual output is less than what the economy can produce at full capacity) has widened.

“While the recent measures announced by the government are likely to help strengthen private consumption and spur private investment activity, the continuing slowdown warrants intensified efforts to restore the growth momentum,” the MPC resolution noted.

“With inflation expected to remain below target in the remaining period of 2019-20 and Q1 (April-June) 2020-21, there is policy space to address these growth concerns by reinvigorating domestic demand within the flexible inflation targeting mandate,” it added.

It is in this context that the MPC decided to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.

Read more:Taking a ‘balanced call’, RBI trims rate by 35 bps

Inflation outlook

With crude oil prices likely to remain volatile in the near term and three-month and one-year inflation expectations of households polled by the Reserve Bank rising in the current round, reflecting near-term price pressures, the retail (consumer price index based) inflation projection has been revised upwards to 3.4 per cent for Q2 (July-September) 2019-20 from 3.1 per cent projected earlier.

However, retail inflation projections for H2 (October-March) 2019-20 and Q1 2020-21 have been retained at 3.5-3.7 per cent and 3.6 per cent, respectively, with risks evenly balanced.

GDP growth

The RBI has revised downwards the real GDP growth for 2019-20 I to 6.1 per cent for 2019-20 from its August forecast of 6.9 per cent --- 5.3 per cent in second quarter of 2019-20 and in the range of 6.6-7.2 per cent for second half of 2019-20 – with risks evenly balanced; GDP growth for first quarter of 2020-21 is also revised downwards to 7.2 per cent.

Read more:RBI revises GDP growth forecast to 6.1%

“The MPC notes that the negative output gap has widened further. While the recent measures announced by the government are likely to help strengthen private consumption and spur private investment activity, the continuing slowdown warrants intensified efforts to restore the growth momentum.”

All members of the MPC voted to reduce the policy repo rate and to continue with the accommodative stance of monetary policy. Ravindra H. Dholakia voted to reduce the repo rate by 40 basis points. Others wanted to cut rates by 25 basis points.

“It is in this context that the MPC decided to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target,” the MPC stressed.

Related news:RBI raises lending capacities of MFIs

However, retail inflation estimate has been slightly revised up to 3.4 per cent for the second quarter of the fiscal while projections are retained at 3.5-3.7 per cent for the second half of 2019-20 and 3.6 per cent for the first quarter of 2020-21, with risks evenly balanced

Monetary transmission has remained staggered and incomplete, the RBI also noted.  As against the cumulative policy repo rate reduction of 110 bps during February-August 2019, the weighted average lending rate (WALR) on fresh rupee loans of commercial banks declined by 29 bps, it said, adding that the WALR on outstanding rupee loans increased by 7 bps during the same period.

Following the announced by RBI, the benchmark indices, Sensex and Nifty, shed their early gains at mid-session. The BSE index was trading 240.66 points, or 0.63 per cent, lower at 37,866.21 at 1300 hours. Similarly, the broader NSE Nifty stood 71.85 points, or 0.64 per cent, down at 11,242.15.

Markets Live: Sensex, Nifty back in the red

The rupee pared its early morning gains and was trading marginally down by 2 paise at 70.89 against the US dollar after the central bank's announcement. Read more:Rupee pares early gains post RBI rate cut

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