In a surprise move, the monetary policy committee (MPC) of the Reserve Bank of India (RBI) stood pat on policy rates on Thursday, as it waited for the full pass-through of past policy rate reductions.

The six-member committee unanimously voted to keep the repo rate—the rate at which banks borrow from RBI—unchanged at 5.15%. None of the 10 economists and bankers surveyed by Mint had predicted the move. The committee said it will maintain an “accommodative stance as long as it is necessary" but made it clear that there is a need to optimize the impact of rate reductions.

“The MPC recognizes that there is monetary policy space for future action. However, given the evolving growth-inflation dynamics, the MPC felt it appropriate to take a pause at this juncture. Accordingly, the MPC decided to keep the policy repo rate unchanged and continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target," RBI governor Shaktikanta Das said in his policy statement.

The surprise move was prompted by a spike in headline inflation above the 4% medium-term target in October, while growth fell to a six-year low of 4.5% in the September quarter. The committee acknowledged that growth has weakened further, adding that removing impediments to future investments is the need of the hour. Accordingly, MPC sharply reduced its growth forecast for 2019-20 to 5% from 6.1%.

The play after pause
The play after pause

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“The need at this juncture is to address impediments, which are holding back investments. The introduction of external benchmarks 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 savings schemes," said Das. “The forthcoming Union budget will provide better insight into further measures to be undertaken by the government and their impact on growth."

RBI also revised its inflation forecast for the second half of the current fiscal to 4.7-5.1% from 3.5-3.7%. This comes after consumer price inflation quickened to 4.62% in October, breaching the 4% target for the first time since July 2018. The committee noted that inflation is expected to moderate below the target by the second quarter of fiscal 2020-21 and that it would await data for more clarity on the inflation outlook.

Despite cutting policy rates by 135 basis points so far this year, new loans have seen a transmission of only 44 basis points so far. Das said MPC would rather wait for the lending rate to reflect full transmission before going ahead with a rate cut.

RBI holding policy rates has reduced expectations of another cut before the end of the current fiscal. Economists believe that a rate cut is off the table as consumer price inflation is expected to remain high in the months ahead. Food inflation is expected to start easing, but the recent hike in telecom tariffs is expected to push up core inflation in December. The market will be closely watching the budget for the government’s fiscal stance and any sector-specific measures to revive the economy.

“Given RBI’s focus on recent inflation spikes and its near-term forecasts (4.7-5.1% in H2), there is a possibility that RBI might stay on hold even at its next policy meeting in February. We expect the inflation readings until February to remain above 5%," Abheek Barua, chief economist at HDFC Bank, said in a research report. “Moreover, if fiscal policy is expansionary in the upcoming budget and provides some support for growth, RBI could further be convinced to hold back rate cuts."

According to Siddhartha Sanyal, chief economist and head of research at Bandhan Bank, RBI could look at further easing in the first half of 2020-21.

“It was a close call this time for MPC, given the combination of a sharp weakness in growth as well as rising headline inflation prints," Sanyal said. “However, the current spike in CPI is driven by a small segment of perishables and food products rather than a generalized price upsurge. We expect CPI to soften in the next 2-3 months, reopening space for further monetary easing during H1 2020. The December MPC decision should be seen as a pause and not the end of the easing cycle."

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