The Reserve Bank of India (RBI) on Thursday surprised the markets by exercising a “temporary pause” on its interest rate, as it waits to get more clarity on inflation and government measures in the upcoming Budget in February, before re-engaging with the Centre on the “national endeavour” of lifting growth.
The six-member monetary policy committee (MPC), headed by RBI Governor Shaktikanta Das, voted unanimously to keep the policy repo rate unchanged at 5.15 per cent. The RBI, however, revised its outlook for growth and inflation. The central bank revised down its 2019-20 growth forecast to 5 per cent from 6.1 per cent in the October policy review. The inflation forecast for the second half of 2019-20 was revised up from 3.5-3.7 per cent to 5.1-4.7 per cent.
Gross domestic product (GDP) growth for the second quarter came in at 4.5 per cent, the lowest since March 2012-13, according to the official data released recently. But the RBI is not worried about the slowdown, Das said in the policy press conference.
“We are just waiting for greater clarity. The government has taken several measures and the RBI has also reduced its rates subsequently. Liquidity has been in surplus mode. We should also allow some more time for the rate cuts to play out to be reflected properly. Therefore, the MPC decided to take a temporary pause,” Das said responding to a media query.
“There is a case of looking through the current spike in headline inflation, which is mainly due to a rise in food inflation. Our calculations show that food inflation in Q4FY20 is supposed to remain very high,” he said, adding that prices would start easing from February.
The market and economists were expecting a sure cut in the policy review, considering the weak growth rate.
The 10-year bond yields jumped about 15 basis points (bps) to close at 6.613 per cent on Thursday. Prices drop as yields rise.
“I cannot remember the last time there has been such a resounding surprise as far as the RBI decision is concerned. It defies the expectation of the market and also the body language of the central bank over the last six months or so when it seemed amenable towards out-of-the-box thinking and being very proactive in terms of supporting growth,” said Taimur Baig, chief economist of DBS Group.
The central bank though assured that it would continue with the accommodative stance as long as required and that there was more room for cuts if there was a need. It is likely that the government may initiate some more counter-cyclical fiscal and other measures to arrest the slowdown, Das said in his opening remarks. The central bank will also take cues from the upcoming Union Budget before moving on rates.
“At this critical juncture, it is of paramount importance that monetary policy and fiscal policy continue to work in coordination to achieve the best results in the national endeavour to revise growth,” the RBI governor said.
On its part, the RBI has cumulatively cut rates by 135 bps five times in a row, since February. Now, there was a need to “optimise the impact of rate reductions”, the MPC felt. “To say that this policy is a surprise to us is an understatement,” said Suyash Choudhary, head of fixed income of IDFC AMC. “Nominal GDP has collapsed from 11-12 per cent between mid-2016 and mid-2018 to just above 6 per cent for the last reading. Even for the full FY, it is very likely going to be 7-8 per cent. It is very hard to argue against a robust counter-cyclical response for such a drastic fall in nominal growth,” Choudhary said.
As far as transmission is concerned, it is almost complete in the case of money market instruments, but banks are yet to fully pass it on to their customers for various reasons. Fresh rupee loans have declined by 44 bps on average. But the transmission is expected to improve as customers move to the new lending benchmark from their old base rate and the marginal cost-based lending rate (MCLR) system, the RBI said.
“The RBI decision for a status quo, though an unanticipated policy surprise, is the most appropriate as monetary policy works with a lag,” said State Bank of India chairman Rajnish Kumar, without commenting on further transmission. Kumar is also the chairman of the Indian Banks’ Association (IBA), the apex banking lobby in the country.
The need at this juncture, according to the monetary policy statement, “is to address impediments, which are holding back investments”.
Governor Das explained those impediments might include certain reforms, particularly with regard to contractual appointments, ease of doing business etc, which the government is already trying to clear through the Parliamentary process.
The RBI, on its part, cannot pursue multiple objectives and it doesn’t mind getting into a negative real interest rate territory. “The MPC cannot pursue multiple targets. The target is to maintain price stability keeping in mind the objective of growth,” and so any rate cut will have to keep in mind the impact on inflation too.