Rate cut season back after 18 months as RBI moves to lift growth momentum

RBI Governor Shaktikanta Das hinted the central bank was open to more rate cuts, though he cautioned the monetary policy committee's decision on this regard would be 'data-driven'

The Reserve Bank of India (RBI) on Thursday went against the consensus and cut the policy rate by 25 basis points to give a lift to the growth momentum of the economy, a key concern for the poll-bound government.

The government initiated populist measures in its interim Budget last week. Following the cut, the first in 18 months, the policy repo rate stands at 6.25 per cent, and the stance is now changed to “neutral” from “calibrated tightening” earlier.

The six-member monetary policy committee, headed by newly appointed RBI Governor Shaktikanta Das, voted four against two in favour of a cut. 

RBI Deputy Governor Viral Acharya advocated a pause, but perennial hawk RBI Executive Director Michael Patra voted for a cut. 

External member Chetan Ghate was the other member who proposed a pause. The stance change decision, however, was unanimous. Most economists had expected a pause in rates, citing steep and sticky core inflation, even as the headline numbers recorded a benign 2.2 per cent in December. 

The RBI governor, however, said inflation would still be contained at 4 per cent or below over the next one year, which has “opened up space for policy action”. 

The inflation outlook was revised slightly to 2.8 per cent for the fourth quarter of 2018-19, 3.2-3.4 per cent for the first half of 2019-20 and 3.9 per cent for the December quarter of 2019-20. 

The governor noted inflation expectations of households have softened by 80 basis points for the three-month horizon ahead and by 130 basis points for the 12-month horizon, while producers assess that inflation in prices of farm inputs and industrial raw materials eased in the December quarter while growth in rural wages moderated.

While the RBI did acknowledge that core inflation at an elevated level (above 5 per cent) tends to be more persistent and pushes up the headline numbers, the central bank’s projection of inflation at 3.9 per cent for the rest of the calendar year does factor in such stickiness, Das said. 

Food inflation, however, is volatile and is difficult to factor in though a spike in the health- and education-led inflation rates could be temporary. The inflation outlook also covers any possible spike due to the expansionary budget proposals.

According to the RBI governor, investment is recovering, but supported mainly by public spending on infrastructure. There was a need to strengthen private investment as well as buttress private consumption.

“The favourable macroeconomic configuration that is evolving underscores the need to act now when it is most opportune. In pursuance of the provision of the Reserve Bank of India Act … it is vital to act decisively and in a timely manner to address the objective of growth once the objective of price stability as defined in the Act is achieved,” Das said in his opening remarks. 

Das hinted the central bank was open to more rate cuts, though he cautioned the monetary policy committee’s decision on this regard would be “data-driven”. The primary objective of the policy continues to be maintaining price stability, keeping in mind the growth objective.

“The shift in stance of monetary policy from ‘calibrated tightening’ to ‘neutral’ also provides flexibility and the room to address challenges to sustained growth of the Indian economy over the coming months as long as the inflation outlook remains benign,” he said.

The central bank continues to expect growth for fiscal 2019-20 at 7.4 per cent. 

The bond market, although exhibiting some volatility, did not move much after the policy. The benchmark 10-year bond yield closed at 7.32 per cent from 7.36 per cent on Wednesday. The rupee strengthened 10 paise to close at 71.46 a dollar.

“Today’s decision is likely to dispel the notion that the RBI is only in the business of hiking rates and chooses to look askance when prices soften. This ‘symmetry’ in rate action was important to establish the credibility of this relatively new policy model,” said HDFC Bank Chief Economist Abheek Barua in a report. 

The idea is that as long as inflation is within the legislative mandate of 4 per cent plus minus 2 per cent, the RBI should focus on growth, Das said in his opening remark.

The monetary policy statement said the “output gap” had opened up modestly because actual output had inched lower than the potential. In the last two policies, this gap was almost closed, noted CRISIL Ltd Chief Economist Dharmakirti Joshi.

However, “opening up of the output gap, … and improvement in capacity utilisation at the same time appear to be somewhat at odds”, Joshi said, adding, the central bank’s growth projection of 7.4 per cent for the next fiscal is “reasonably strong”.

The RBI governor said the transmission of monetary policy action was important and he would be meeting bankers in the coming days on that. But he observed while bank credit flows had picked up and so did overall flows to the commercial sector, they are yet to become broadbased. 

RBI officials said the central bank would ensure adequate liquidity for the system, and that would be helpful for non-banking financial companies as well.

Whether more banks would get out of the prompt corrective action (PCA) framework of the RBI would depend upon their performance. 

The governor said the RBI’s board would decide on the interim dividend and it would be transferred in accordance with the rules. 

“Payment of dividend or surplus from the RBI is part of the RBI Act, it is a legal provision. How the government uses the proceeds of this surplus or dividend, it is the government’s decision,” Das said, adding, any decision of the RBI would be driven by certain principles and accounting norms.

The policy had a number of important steps that would allow more foreign capital to come to India. The central bank allowed bidders for companies undergoing insolvency resolution to tap external commercial borrowings to pay the domestic rupee debt of target companies. It allowed banks to assign risk-weights for loans given to NBFCs, based on their credit ratings. Also, the RBI abolished different categories of NBFCs.

The central bank rolled back restrictions on foreign portfolio investors (FPIs) that had barred them from having more than 20 per cent of their portfolio exposed to a single corporate. 

The central bank also increased the limit of collateral-free agriculture loans by Rs 60,000 each to Rs 1.6 lakh to help enhance the coverage of small and marginal farmers in the formal credit cycle.