In keeping with market expectations, the Reserve Bank of India (RBI) cut lending rates for the second time in two months to support a sluggish economy; the move came in its first bi-monthly Monetary Policy Committee (MPC) meeting of the financial year 2019-20.
The central bank revised the repo rate downward by 25 basis points (or 0.25) to 6% while retaining its policy stance at “neutral” and reversing the GDP growth projection for 2019-20. The six-member MPC, which was raised the GDP from 7.2% to 7.4% in February, was revised it to 7.2% on Thursday, in the face of economic headwinds and global uncertainty.
The RBI Governor Shaktikanta Das-headed MPC adjusted the reverse repo rate under the liquidity adjustment facility (LAF) to 5.75%, and the marginal standing facility (MSF) rate and Bank Rate to 6.25%.
Policy rates and inflation: revised down
The lending rate had been reduced for the first time in 18 months in the last policy meet in February, again by 25 bps, to 6.25%. This gave certain sections of the market reason to hope for a deeper 50bps rate cut this time, while economists expected an accommodative stance from a neutral one.
But as Shubhada Rao of YES Bank writes for BloombergQuint, with increasing dovishness across advanced economies around the world, a calibrated easing of monetary policies is on the cards at best.
In the last meeting, only four members, namely Ravindra H Dholakia, Pami Dua, Michael Debabrata Patra, and Shaktikanta Das had voted in favour of the reduction in repo rate cut, while Chetan Ghate and Viral Acharya had voted to keep the policy rate unchanged.
From November 2018 to February 2019, Consumer Price Index (CPI) inflation in India averaged at 2.2%, causing the MPC to abandon its calibrated tightening stance in February and adopting a neutral one.
However, analysts believe there are other drivers behind RBI’s latest decision to refrain from a more aggressive monetary easing response, especially when RBI’s inflation estimate for FY20, as provided in its April policy review, is 40 bps lower than that predicted in March.
Moreover, retail inflation, which was pegged at 2.8% in the last policy meet, was also lowered to 2.4% for the fourth quarter of 2018-19. But for food and fuel inflation, CPI is lower than expected.
Then why not relax lending rate further?
El Nino-related weather disturbances during Indian monsoons, ongoing uncertainties over crude oil prices, and international trade are likely to keep MPC in a data-dependent neutral mode, which means that although a hike in the repo rate is off the table, the MPC is not obliged to cut it further in successive policy meetings. In the last meeting itself, Das had clarified that all further policy decisions would be data-driven.
As noted in Qrius‘s report on the last policy review, India, like most key economies, has turned decisively dovish or completely eliminated hawkishness. The RBI, for example, has cut GDP growth projection for 2019-20 again, to 7.2% versus 7.4% forecast in February policy meet.
Why was the GDP re-revised?
The last policy review had projected the economic growth rate of 7.4% for the next fiscal, up from the 7.2% estimated by the Central Statistics Office (CSO) for FY18-19. The growth in GDP had then been ascribed to the growth in bank credit and overall financial flows to the commercial sector.
Nonetheless, it noted signs of weakening domestic investment activity and slowing global demand that could dampen future prospects of growth.
In particular, trade tensions and associated uncertainties appear to be moderating global growth, the policy review document said, referring to the ongoing tariff war between the US and China and other geo-political uncertainties.
Why this matters
A significant decline in trend growth rate has been the topic of debates on whether the central banks monetary policy in its exuberance for inflation control is stifling growth. The Indian Express, in a recent piece, however, noted that the key consideration for the RBI has finally shifted from inflation to growth. This explains the downward revision of the GDP, back to its earlier estimate.
The reduction in GDP growth rests on the slowdown in of capital goods and consumption, both public and private, which in turn will impact Indian exports. Furthermore, the fluctuating pace of global economic growth due to softening demand and contracting manufacturing activity stand to disrupt India’s growth prospects in the near future.
LiveMint claims that the rupee has gained 1% so far this year, while foreign investors have bought $8.51 billion in equity and $1.03 billion in market. Following the RBI’s decision on Thursday, the disappointment of traders was registered in the weakening of the rupee and a surge in 10-year-bond by nearly 7 basis points
: Rupee back on top: All you need to know
CARE Ratings expect a 25-50 bps rate cut over the year given that the RBI has lowered its projections for inflation and economic growth while adopting a data-dependent approach. But experts recommend milder monetary policy tightening to moderate the negative effects of supply shocks.
How this can affect you
On the plank of the two successive 0.25% cuts in repo rate, the MPC recommends strengthening private investment activity and buttressing private consumption, which has remained resilient.
Business expectations, too, have every reason to continue to be optimistic as higher financial flows to the commercial sector could spell a boom in economic activity, which is recovering supported by increased public spending in rural areas and rising disposable incomes of households due to tax benefits.
So, this announcement is a way of complementing the Union Interim Budgets proposals that will increase disposable income for salaried taxpayers.
According to the new budget proposal, salaried employees earning up to Rs 5 lakh a year would be exempted from income tax, and those earning Rs 6.5 lakh per annum would also be exempted if they availed the Rs 1.5 lakh exemption available under Section 80C of the Income Tax Act. The Tax Deduction at Source (TDS) threshold on interest earned on bank/post office deposits would be raised from Rs 10,000 to Rs 40,000. Further, the TDS threshold for deduction of tax on rent has also been proposed to be increased from Rs 1.8 lakh to Rs 2.4 lakh.
The lowering of the repo rate with immediate effect is especially good news for borrowers in the election season, as EMIs are likely to go down for retail borrowers, as soon as banks follow suit, pass on the benefits of the lowered rates to the end consumers, and reduce their marginal cost of funds-based lending rates (MCLR)
to a Business Today report, ICICI Bank, HDFC Bank, Bank of Baroda, Punjab National Bank, Kotak Mahindra Bank, YES Bank, and Union Bank of India lowered their MCLRs (internal benchmark below which banks cannot lend) recently by 5-15 basis points.
Prarthana Mitra is a Staff Writer at Qrius