RBI changes stance to calibrated tightening; key takeaways from policy meet

Springing a surprise, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) on Friday kept the repo rate unchanged at 6.50 per cent. Most analysts had expected the central bank to hike rates by 25 bps.

The repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall in funds.

Giving the rationale behind RBI's move, Sujan Hajra, Chief Economist at Anand Rathi Financial Services, said, "With the disturbances in the money/debt market sparked off by IL&FSs default on debt, RBI has initiated numerous liquidity easing measures including aggressive Open Market purchase of bonds. These liquidity easing measures run contrary to the two successive hikes in repo rate (In Jun and Aug'18). Moreover, with the actual retail inflation coming below RBI's projections in the last two months, the rate pause in October 2018 is not altogether unexpected. The reduction of customs duty on crude oil and cut in taxes on petroleum products by select states also provided some comfort to RBI on the inflation front."

Consequently, the reverse repo rate remained unchanged at 6.25 per cent, with marginal standing facility (MSF) and bank rate at 6.75 per cent.

Here're the key takeaways from RBI's fourth bi-monthly monetary policy meet:

MPC changes stance to 'Calibrated Tightening'

The RBI shifted its monetary policy stance to Calibrated Tightening, which means rate cut is off the table this cycle. It also means "we are not bound to increase interest rates every meeting, because that's not needed," explained RBI Governor Urjit Patel. Speculation was rife that the central bank would change its policy stance. "This is a risky move by the RBI since the market was positioned for a rate hike, purely as a rupee defence. In its absence, currency and asset markets could see sharper corrections. A narrow focus on inflation targets perhaps not desirable in the middle of a financial crisis. Change in stance suggests that the rate hike could still come in the coming months," said Abheek Barua, Chief Economist at HDFC Bank.

RBI lowers inflation projection

The RBI said that inflation is projected at 4 per cent in Q2 of 2018-19, 3.9-4.5 per cent in H2 and 4.8 per cent in Q1 of 2019-20, with risks, somewhat to the upside. In the third bi-monthly resolution of August 2018, CPI inflation was projected at 4.6 per cent in Q2 of 2018-19, 4.8 per cent in H2 and 5.0 per cent in Q1 of 2019-20. However, the RBI noted that while the projections of inflation for 2018-19 and Q1 of 2019-20 has been revised downwards from the August resolution, its trajectory is projected to rise above the August 2018 print. It added that global headwinds in the form of escalating trade tensions, volatile and rising oil prices, and tightening of global financial conditions pose substantial risks to the growth and inflation outlook.

"The status quo decision along with a slight downside revision to inflation comes as a surprise given the sharp upside risks to the inflation trajectory in the months ahead on the back of elevated crude oil prices and weaker Rupee. We believe inflation is expected to overshoot RBI’s estimate in 2H (3.9-4.5 per cent) by 20-30bps," said Upasana Bhardwaj- Senior Economist, Kotak Mahindra Bank.

GDP growth projection retained at 7.4%

Based on an overall assessment, GDP growth projection for 2018-19 has been retained at 7.4 per cent as in the August resolution (7.4 per cent in Q2 and 7.1-7.3 per cent in H2), with risks broadly balanced; the path in the August resolution was 7.5 per cent in Q2:2018-19 and 7.3-7.4 per cent in H2. GDP growth for Q1:2019-20 is now projected marginally lower at 7.4 per cent as against 7.5 per cent in the August resolution, mainly due to the strong base effect. The MPC said that the GDP print of Q1 of 2018-19 was significantly higher than that projected in the August resolution.

On financial conditions and investment activity

The MPC noted that improving capacity utilisation, larger FDI inflows and increased financial resources to the corporate sector augur well for investment activity. However, both global and domestic financial conditions have tightened, which may dampen investment activity. Rising crude oil prices and other input costs may also drag down investment activity by denting profit margins of corporates. This adverse impact will be alleviated to the extent corporates are able to pass on increases in their input costs. Uncertainty surrounds the outlook for exports. Tailwinds from the recent depreciation of the rupee could be muted by the slowing down of global trade and the escalating tariff war.

System liquidity
 

The MPC noted that systemic liquidity alternated between surplus and deficit during August-September 2018. It said that after turning into surplus during August 31-September 10 due to increased government spending, the system again moved into deficit during September 11-29 on the back of an increase in government cash balances and Reserve Bank’s forex interventions. Based on an assessment of the evolving liquidity conditions, the Reserve Bank conducted two open market purchase operations in the second half of September to inject Rs 200 billion of durable liquidity.