Hawk turns dove

Having a new Governor at the helm of the Reserve Bank of India seems to have wrought a sea change in the Monetary Policy Committee’s view on the state of the Indian economy, its inflation outlook and the liquidity situation in the debt markets. It has surprised market participants with a 25-basis point cut in its repo rate and switched its policy stance from ‘calibrated tightening’ to ‘neutral’, when the markets were primed for another do-nothing policy review. With the RBI now on the same page as the Centre on the need for accommodation, this rate cut, coming on top of a please-all Budget, seems designed to infuse animal spirits into a tired economy.

There are three aspects on which the MPC has shifted gears. One, after consistently over-estimating inflation risks and obdurately sticking to a hawkish tone in its previous reviews, the MPC has finally taken note of deflating food prices to adopt a dovish view this time around. Slashing its inflation forecast for H1FY20 by a drastic 60-80 basis points to 3.2-3.4 per cent, the MPC has stuck its neck out to predict a 3.9 per cent inflation rate in Q3FY20 as well. The policy statement downplays the impact of the base effect and oil prices on short-term inflation prints, while cheering the ‘significant moderation’ in household inflation expectations. All this no doubt prepares the ground for further rate cuts in the coming months. But one wonders if the MPC is going too far in making its case, when it dismisses the rise in the health and education components of inflation as ‘one-off’ and downplays the impact of fiscal slippages on inflation rates. Two, after taking an inexplicably sanguine view of the economy in the past, the MPC has been more realistic this time around — flagging uneven credit flow to industry, slowing global demand and trade tensions as headwinds to growth. But it has stopped short of pruning its 7.4 per cent growth forecast for FY20. Three, in a tacit admission of a selective liquidity crunch, the RBI has announced a bunch of regulatory relaxations to go with this policy review. Allowing corporate resolution applicants to use ECBs to repay Rupee loans, relaxing risk weights for bank lending to NBFCs and liberalising exposure limits for FPIs in corporate debt, are all designed to step up the flow of credit and liquidity to distressed corporate borrowers.

While this policy review has injected dollops of feel-good into the debt markets, it remains to be seen if it materially lowers borrowing costs for Indian businesses. The risk perception attached to domestic NBFC/corporate borrowers has shot up sharply in recent months after the series of scandals rocking India Inc. In the circumstances, it is doubtful if either banks or bond market participants will rush to lower their lending rates, just because the MPC has effected a long overdue cut in its policy rates.

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