Monetary policy review: RBI holds rates, keeps door open for cuts in future

The Reserve Bank of India (RBI), in its sixth bi-monthly monetary policy of 2019-20 on Thursday, kept its policy rates and stance unchanged but adopted unconventional measures to lower banks’ cost of funds so that they could reduce their lending rates further and boost retail advances to revive consumption demand.

The six-member monetary policy committee (MPC) voted unanimously to keep the rates unchanged because the inflation outlook remained “highly uncertain.”

While the repo rate remained at 5.15 per cent and the stance “accommodative”, the central bank said there would be rate cuts as and when opportunity came. 

Right now, with inflation being 7.4 per cent, the rate cut scope was not there.

“Definitely. We have the policy space, but it will depend on the evolving situation and as the MPC was proactive in 2019, it will be very, very proactive even in 2020,” RBI Governor Shaktikanta Das said during his post-policy press conference.

In his opening remarks, the governor cautioned that while the status quo policy was expected, the RBI’s ability to steer growth should not be doubted.

“While this decision may be on expected lines and perhaps widely discounted, it is important not to discount the RBI! It has to be kept in mind that the central bank has several instruments at its command that it can deploy to address the challenges that the Indian economy currently faces in terms of sluggishness in the growth momentum,” Das said.

“Consequently, even though the present monetary policy decision is constrained by elevated inflation pressures, there are other ways in which the RBI can strive to revive growth.”

Accordingly, the RBI introduced novel concepts, which analysts hailed as noteworthy experimentations. 

“The policy is extremely dovish. Without doing a rate cut, the RBI has achieved more than that,” said Ananth Narayan, associate professor at S P Jain Institute of Management and Research. 

The RBI told banks they could keep loans to automobiles, residential housing, and micro, small and medium enterprises (MSMEs) outside the purview of the cash reserve ratio, which is 4 per cent of their deposits. What’s given to these sectors can be deducted from their deposits, and the banks will not have to maintain the CRR on it. The window of opportunity would remain active between the fortnight ended January 31 and July 31. 

The RBI will not buy bonds directly from the government to finance the deficit, the governor said. The government exercised the trigger clause in the Budget to adopt a fiscal deficit of 3.8 per cent for the present fiscal, instead of 3.3 per cent estimated earlier. However, the rules also allow the government to tap the RBI to monetise its deficits by buying bonds and printing money. “At the moment there is no plan of monetising the government deficit,” Das said.

The central bank also rejigged how it injected and absorbed liquidity in the banking system and did away with the daily liquidity window in favour of liquidity infusion on a variable rate basis every 14 days.

However, if the banking system is short of money, the RBI won’t hesitate to undertake its traditional tools of liquidity management such as fixed and variable rate repo/reverse repo auctions, outright open market operations (OMOs), forex swaps and other instruments.

As part of the new framework, the central bank also introduced ultra-long term repo operations (LTRO). These will be two liquidity instruments that can be used by banks to borrow money for one year and three years at the existing repo rate. However, this instrument can be used to borrow up to Rs 1 trillion of liquidity only, in different sizes. RBI Deputy Governor N S Vishwanathan said the idea was that banks should not sit on cash. After the policy, the government one-year bond yield fell 8 basis points (bps), the three-year bond 19 bps, and the five-year bond 15 bps. The 10-year bond yield fell 6 bps to 6.449 per cent from its previous close. SBI Chairman Rajnish Kumar said the special CRR dispensation as well as LTRO would bring down cost of funds for banks and “facilitate better transmission within the current constraints of downward rigidity of deposit rates”.

The RBI said it was satisfied with the transmission so far. While the RBI lowered rates by 135 basis points between February and December last year, transmission to various money and corporate debt market segments up to January 31 ranged from 146 basis points (bps) to 190 bps. The 10-year government bond yields came down 76 bps and banks’ MCLR came down between 55 bps to 69 bps. While onion prices would moderate going forward, pulses and protein prices may go up, it said. RBI, therefore, revised its inflation projection to 5.4-5.0 per cent for the first half of fiscal 2020-21 from 4-3.8 per cent in December policy. 

“The MPC will remain vigilant about the potential generalisation of inflationary pressures as several of the underlying factors cited earlier appear to be operating in concert,” the RBI’s policy statement said.

The RBI also lowered the GDP growth forecasts for the first half of fiscal 2020-21 to 5.5-6 per cent from 5.9-6.3 per cent in the earlier policy. “Looking ahead, the pick-up in GDP growth in 2020-21 is likely to be led by private consumption, which should benefit from higher spending power on account of the reduction in GST rates and income tax rate reductions for middle-income slabs,” Das said in his opening remarks.