RBI monetary policy: Wider output gap drives fifth consecutive rate cut

In line with our expectation, the monetary policy committee (MPC) reduced the repo rate by 25 basis points (bps) to 5.15 per cent in its October 2019 policy review, bringing the total magnitude of easing so far in this cycle to 135 bps, over the course of 2019. The MPC unanimously voted to reduce the policy rate and maintain the stance as accommodative, even as one of the members voted for a larger rate cut of 40 bps.

The widening of the negative output gap paired with the relatively stable retail inflation prints in the recent months, as well as the expectation of range bound CPI inflation over the next three quarters, supported the decision of the MPC. 

The MPC modestly revised its CPI inflation forecast for Q2 FY2020 to 3.4 per cent from 3.1 per cent in August 2019. This is in line with the hardening in vegetable prices, which is expected to reverse. Aside from this, the Committee remarked that the outlook for food inflation has improved since the August 2019 policy review. Partly benefitting from this, the inflation estimates for H2 FY2020 and Q1 FY2021 were retained at 3.5-3.7 per cent and 3.6 per cent, respectively, with risks evenly balanced.

Aditi Nayar, Principal economist ICRA

Following the disappointing GDP growth of 5.0 per cent in Q1 FY2020, and the sluggish performance of various high frequency indicators in Q2 FY2020, the Committee has sharply reduced its projection for economic growth for FY2020 to 6.1 per cent (with risks evenly balanced) from the prevailing 6.9 per cent, with risks to the downside). Moreover, it has corrected its forecast for GDP growth for Q1 FY2021 to 7.2 per cent from 7.4 per cent.

Although the transmission of monetary easing undertaken so far has been staggered and incomplete, it is expected to improve going forward. Moreover, the measures announced by the government would support investment activity and boost foreign direct investment over the medium term. However, capacity utilisation levels remained moderate at 73.6 per cent in Q1 FY2020, which may prevent a quick revival in investment activity until there are clearer signs of a broad improvement in domestic consumption demand and the exports outlook. 

The MPC clearly enunciated that it would retain the stance as accommodative for as long as necessary to revive growth. This suggests that the repo rate may be reduced further in the December 2019 policy review, particularly if the GDP growth for Q2 FY2020 is disappointing. 

Views are personal