Money & Banking

RBI pauses on rate cuts amid rising inflation

Our Bureau Mumbai | Updated on December 05, 2019 Published on December 05, 2019

Central bank lowers GDP growth forecast for FY20 to 5 per cent

Contrary to expectations of a policy rate cut, the Reserve Bank of India on Thursday hit the pause button amid worries over rising retail inflation. However, the central bank said there was room for a further rate cut in the future even as it was expecting the full impact of the previous rate cuts to play out amidst ample liquidity in the financial system.

 

In its 5th bi-monthly monetary policy review, the central bank cut the GDP growth projection for FY20 sharply to 5 per cent from 6.1 per cent projected earlier. In the previous monetary policy review, the GDP growth was revised downwards to 6.1 per cent from 6.9 per cent projected earlier.

The RBI upped the retail inflation projection for the second half of FY20 to 5.1-4.7 per cent against the earlier projection of 3.5-3.7 per cent .

The repo rate, which is the interest rate at which the RBI lends funds to banks to help them overcome short-term liquidity mismatches, currently stands at 5.15 per cent.

Accomodative stance

All six members of the monetary policy committee (MPC) voted in favour of the decision to maintain status quo on the repo rate. They also decided to continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that the objective of achieving the 4 per cent medium-term target for consumer price index (CPI) based inflation, with an upper and lower tolerance limit of 6 per cent and 2 per cent, respectively, was pursued.

The pause comes after the RBI cut the policy repo rate cumulatively by 135 basis points in the last nine months to revive the economy.

The MPC recognised that there is monetary policy space for future action. However, given the evolving growth-inflation dynamic, the committee felt it appropriate to pause at this juncture.

“We want the earlier rate cuts to play out fully. And we cannot be, sort of, mechanically reducing the rate every time. We have to see that the rate cut, whenever it is undertaken, is done in a manner so that it has maximum impact,” Governor Shaktikanta Das said at the 5th bi-monthly monetary policy press meet.

The Governor emphasised that more time should be allowed for the full impact of the combined measures undertaken by the government and the monetary easing undertaken consistently so far by the RBI to unfold and play out.

The MPC assessed that inflation is rising in the near-term, but it is likely to moderate below target by Q2 (July-September):2020-21.

“It is, therefore, prudent to carefully monitor incoming data to gain clarity on the inflation outlook. Similarly, the forthcoming Union Budget will provide better insights into further measures to be undertaken by the government and their impact on growth,” the MPC resolution said.

Rajnish Kumar, Chairman, State Bank of India, and Chairman, Indian Banks’ Association, said: “The RBI decision for a status quo though an unanticipated policy surprise is the most appropriate as monetary policy works with a lag. The lowering of the GDP growth for FY20 and FY21 reflects continued growth conundrums and a slow recovery.”

The MPC observed that the introduction of external benchmark-linked lending is expected to strengthen monetary transmission. In this context, there is also a need for greater flexibility in the adjustment in interest rates on small saving schemes, it added.

Weak economic activity

The MPC noted that economic activity has weakened further and the output gap remains negative (actual output is less than what the economy could produce at full capacity). However, several measures already initiated by the government and the monetary easing undertaken by the RBI since February are gradually expected to further feed into the real economy.

“Data on corporate finance and on projects sanctioned by banks and financial institutions suggests some early signs of recovery in investment activity, though its sustainability needs to be watched closely. The need at this juncture is to address impediments, which are holding back investments,” the MPC’s resolution stated.

Published on December 05, 2019
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