RBI cuts repo rate by 25 basis points but room for more uncertain
Mumbai: The monetary policy committee (MPC) of the Reserve Bank of India (RBI) on Wednesday cut its key policy rate by 25 basis points (bps), citing a sharp fall in consumer price inflation and the need to boost investment demand in the economy.
MPC reduced the repo rate—at which the central bank infuses liquidity in the banking system—to 6%, the lowest since November 2010, from 6.25%. The panel maintained its forecast for gross value-added growth , a measure of economics output, for the current fiscal year at 7.3%.
But the six-member panel maintained the neutral policy stance to which it moved from an accommodative stance in February, citing uncertainties in the inflation trajectory stemming from factors such as the impact of farm loan waivers on state finances. This left economists divided on the room RBI has for any more rate cuts this year.
Four members of the MPC, including RBI governor Urjit Patel, voted for a 25 bps reduction. Ravindra Dholakia, a professor at the Indian Institute of Management, Ahmedabad, wanted a 50 bps cut, while RBI executive director Michael Patra sought to leave the repo rate steady. One basis point is one-hundredth of a percentage point.
Some of the upside risks to inflation such as high core inflation (excluding food and fuel prices), poor rains and adverse impact from the rollout of the goods and services tax (GST) have not materialized, opening up space for monetary policy accommodation, the MPC noted.
Retail prices rose 1.5% in June, lower than RBI’s April-September inflation forecast of 2-3.5%. Inflation slowed mainly because of falling food prices and the base effect. Even core inflation has declined in the past two readings after remaining sticky for a while.
Patel called it an “opportune time” for a rate cut. But MPC noted that inflation can only be expected to rise from here on.
“Noting, however, that the trajectory of inflation in the baseline projection is expected to rise from current lows, the MPC decided to keep the policy stance neutral and to watch incoming data. The MPC remains focused on its commitment to keeping headline inflation close to 4% on a durable basis,” the monetary policy statement said.
Its projection for headline inflation (excluding the impact of the house rent allowance for government staff) is “a little above 4%” by March-end, compared with an earlier 3.5-4.5%.
Indeed, the panel isn’t fully convinced about whether inflation has structurally moved lower.
“While inflation has fallen to a historic low, a conclusive segregation of transitory and structural factors driving the disinflation is still elusive,” the monetary policy statement said. “The MPC will continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway.”
“To my mind there is room for another 25 bps cut but not in the October policy. They will wait for more data before doing so,” said Gaurav Kapur, chief economist at IndusInd Bank Ltd. “On inflation, they are more or less convinced that it won’t overshoot the 4% target. Hence, growth numbers are crucial for this expectation because it will clear the noise around the GST impact and it will also show if the impact of demonetization continued.”
The rate cut will only mildly support economic revival because other structural measures taken by the government to spur growth will only play out in the medium term, said D.K. Joshi, chief economist at rating company Crisil Ltd.
Private investment demand has been stagnant in India for a long time. In fiscal 2016-17, growth in gross fixed capital formation, a measure of investment demand, was 2.38%. Data from the Centre for Monitoring Indian Economy Pvt. Ltd shows that Indian firms announced Rs1.34 trillion worth of new projects in the June quarter, the lowest since December 2015.
Patel cited a need to reinvigorate private investment, remove infrastructure bottlenecks, boost affordable housing and speed up project clearances.
He also said that given the present condition of surplus liquidity and RBI’s rate cut, he expects banks to fully transmit this to lending rates, especially to sectors which have not seen the benefits of lower rates. He noted that loan rates have come down substantially since January 2015, especially for housing and personal loans.
Deputy governor Viral Acharya said currency in circulation is showing early signs of returning to normal levels (following the November demonetization of high-value bank notes) and the central bank is closely watching these numbers to see if demand for currency is being met and to understand system liquidity conditions. Once RBI gets a sense of the nature of liquidity surplus, it could use various tools, including so-called open market operations, to manage it, he added.
“In our view, there is limited room for another rate cut as RBI is looking to mop up surplus liquidity and bring it to a neutral zone,” said Rajni Thakur, economist at RBL Bank Ltd.
Malvika Joshi contributed to this story.