The Reserve Bank of India’s six-member rate-setting panel on Wednesday cut the repurchase rate to 5.4%, the lowest in almost a decade and more than the 25bps cut expected by most economists. It also decided to retain the monetary policy’s current accommodative stance.
Central bank governor Shaktikanta Das told reporters that the monetary policy committee (MPC) was of the view that the “standard 25 basis point (cut) might prove to be inadequate in view of the evolving global and domestic macroeconomic developments. On the other hand, reducing the rate by, say, 50 basis points might be excessive, especially after taking into account the actions already undertaken".
Reducing the rate by 35bps was, therefore, viewed as balanced, Das said. This is the second-biggest rate cut in recent times after RBI reduced the repo rate by 50bps twice: once in April 2012 and next in September 2015.
With inflation expected to remain benign amid slowing consumption and investment growth, which threatens to further slow down economic growth, MPC’s focus has now fully shifted from combating inflation to boosting aggregate demand. The central bank has traditionally balanced its policy narrative between growth imperatives and inflation management, but the policy focus now seems solely reassigned to minimizing the negative output gap. The unconventional rate cut and the unchanged stance may also signal the central bank’s willingness to make room for future rate cuts.
This comes on top of a system flush with liquidity, driving even the weighted average call money rate below the policy rate; ideally, both should be broadly aligned. In these times of uncertainty—especially in global trade, geopolitics and currency markets—the central bank has provided certitude on at least one count: rate hikes are definitely off the table for now.
The decision to cut rates by 35bps found support from four MPC members—Ravindra Dholakia, Michael Patra, B.P. Kanungo and governor Shaktikanta Das—while Pami Dua and Chetan Ghate voted for a 25bps reduction. All the members voted unanimously to maintain the monetary policy’s accommodative stance.
Concern now pivots to whether financial agents will be amenable to reducing their lending rates. Transmission from the RBI’s benchmark rates to commercial lending rates has been slow and sticky, with banks reducing their lending rates by only 29bps during the February-June period against RBI’s 75bps cut during the same period.
“Our interactions with various stakeholders, including both public sector and private sector banks, indicate that steps are being taken by them on an ongoing basis to progressively lower their interest rates," Das said.
In response, the nation’s largest lender, State Bank of India (SBI), cut its lending rate on Wednesday by 15bps. The bank claimed in a release that it has reduced working capital lending rates by 85bps during the current fiscal through four cuts. In the past, all state-run banks (and, occasionally, some private banks, too) would wait for SBI’s cues before initiating any rate actions. Given how widely differentiated risk profiles and capital structures have become across banks, it is moot whether SBI’s rate cut would find any immediate response.
As part of the package to improve aggregate demand, the central bank has ensured easy credit flow to consumer credit and to non-banking financial companies (NBFCs). In the accompanying statement on development and regulatory policies, RBI has reduced the risk weight banks need to attach to consumer credit to 100% from 125%, in the hope that this will diminish the banking sector’s aversion to consumer lending and, by extension, boost consumption of a variety of products and services: from cars to white goods, from holidays to college education.
The statement adopts twin modes to open the credit tap wider for NBFCs. The first is by relaxing the prudential limits on a bank’s exposure to a single NBFC from 15% of its tier I capital to 20%. This is also the limit prescribed for other counterparties. Second, banks can meet their priority sector credit targets by lending to NBFCs for on-lending to agriculture investment (up to ₹10 lakh), micro and small entrepreneurs ( ₹20 lakh) and affordable housing ( ₹20 lakh per borrower).
The central bank’s attempts to kick-start growth by easing credit flow stem from its own macroeconomic projections. RBI has been shaving off its growth projections at each successive policy meeting. In effect, RBI has whittled down its GDP growth estimate for 2019-20 by 50bps in the span of five months.
“Our understanding is that at this point, it is a cyclical slowdown and not really a deep structural slowdown. Nonetheless, we have to recognize there is room for certain structural reforms that need to be undertaken," said Das. In short, the ball is now in the government’s court.