Projecting a contraction in growth for the current fiscal year, the Reserve Bank of India (RBI) on Friday went for a further cut of 40 basis points in the policy repo rate even as it warned that inflation, particularly in food, is on the rise again.
The six-member monetary policy committee (MPC) kept the policy stance unchanged at “accommodative” “as long as necessary” to revive growth. “It is in the growth outlook that the MPC judged the risks to be gravest,” RBI Governor Shaktikanta Das said in an online address on Friday morning.
Das noted the MPC had not initially anticipated the impact of the pandemic to be as severe. And so, judging that the risks to growth were acute while those to inflation were likely to be short-lived, the MPC felt it was essential now to “instill confidence and ease financial conditions further”, in order to “facilitate the flow of funds at affordable rates and rekindle investment impulses”, Das said.
The RBI governor painted a grim picture of the economy in his morning address. The two months of lockdown have severely affected industrial production as the top six industrialised states, which account for about 60 per cent of industrial output, are largely in the red or orange zones.
The combined impact of demand compression and supply disruption will depress economic activity in the first half of the year, Das said, adding that even if economic activity got restored in a phased manner in the second half, recovery would be gradual. “Given all these uncertainties, GDP growth in 2020-21 is estimated to remain in negative territory,” Das said.
“The biggest blow from Covid-19 has been to private consumption, which accounts for about 60 per cent of domestic demand,” Das said.
However, agriculture and allied activities have “provided a beacon of hope” on the back of an increase of 3.7 per cent in foodgrains production, which is a record.
According to Das, the inflation rate will fall below the target by the third quarter even as there has been some spurt now due to supply pressure. Once the central bank gets a better handle on the inflation situation, more room for rate cuts would open up.
The MPC voted with a 5-1 majority to reduce the policy rate by 40 basis points from 4.4 per cent to 4.0 per cent. External member Chetan Ghate voted for a 25-basis-point cut. Since March 27, in the midst of the lockdown, the central bank has reduced its policy rate by 115 basis points in two out-of-turn MPC meetings, each lasting three days. On April 17, the RBI governor held another such televised address, where reverse repo rate was reduced by 25 basis points, for which MPC nod was not needed.
This is the lowest repo rate on record, and such rapid downward revisions were last seen during 2008-09, when then governor Duvvuri Subbarao brought it down from 9 per cent in September 2008 to 4.75 per cent in April 2009.
The RBI is not alone in this, though.
Most central banks are not highly concerned about inflation at this stage.
Economists also largely don’t disagree with the RBI’s assessment that prices will soften in the coming months as demand remains subdued and food prices get addressed in the face of a bumper rabi harvest, 44 per cent increase in kharif sowing, and a normal southwest monsoon.
“Of much greater concern would have been the certain growth slowdown and loss of incomes, driven both by demand compression and supply shocks, necessitating a further repo rate cut in an emergency meeting,” said Saugata Bhattacharya, chief economist, Axis Bank.
“This is in line with the thinking of all central banks globally which are unveiling unprecedented post-Covid stimulus responses,” Bhattacharya said.
With the reduction in the repo rate on Friday, the reverse repo rate also stands reduced to 3.35 per cent from 3.75 per cent.
The rupee fell to 75.96 a dollar from its previous close of 75.62, and the Sensex dropped to 260.31 points and closed at 30,672.59 points as the RBI predicted a contraction in growth for 2020-21.
Yields on the most-traded bonds maturing in 2029 fell 7 bps to 5.965 per cent from its previous close of 6.033 per cent.
Apart from the rate actions, the central bank extended its earlier moratorium measures by three months. With this, stressed individuals and companies can forgo servicing their loans till August without fearing a deterioration in their credit profile.
The central bank also said interest payments on working capital could be spread till March 2021, instead of up to September allowed earlier. To enable banks to give more credit to the corporate sector, the RBI increased the group exposure limits of banks to 30 per cent from 25 per cent earlier.
Analysts have started questioning if the growth slowdown can be arrested by RBI rate cuts alone.
“While policy easing is welcome, the effectiveness of rate cuts and excess liquidity on delivering the growth bang is incrementally diminishing in a scenario of rising credit risk aversion among lenders. Hence, while we expect the RBI to deliver more easing, the real policy punch needs to come from unconventional monetary policy to navigate around the balance sheet issues,” said Sonal Varma, chief economist of Nomura India and Asia (ex-Japan).