The RBI’s monetary policy committee on Thursday, February 7, slashed the benchmark interest rate by 25 basis points, changed its stance to “neutral” from “calibrated tightening,” and pegged the growth in GDP for FY20 at 7.4% . Some of the policy announcements are being hailed as paradigmatic for the financial markets.
For the first time in the current fiscal, the repo rate has been lowered to 6.25%, after being maintained at 6.5% over the last four reviews, while the reverse repo rate has been adjusted down to 6%. These are expected to affect private and public investment activities.
Future MPC decisions on policy rates will be data-driven, RBI governor Shaktikanta Das said in his address to the media, after the three-day meeting of the central bank’s Monetary Policy Committee (MPC). The risks are evenly balanced for growth, he added.
This was the first policy review conducted under the tutelage of the new RBI governor, famously known as the man behind GST, just months after his predecessor Urjit Patel resigned amid differences with the central government.
Here are some of the key highlights of the RBI document released after the bi-monthly MPC meeting.
GDP and growth
The policy review projects an economic growth rate of 7.4% for the next fiscal, up from the 7.2% estimated for the current fiscal year by the Central Statistics Office (CSO). The growth in domestic product (GDP) is likely to be influenced by growth in bank credit and overall financial flows to the commercial sector.
Industry experts agree. SBI chairman Rajnish Kumar spoke to Money Control, saying, “The decision to the risk weights for on lending to rated NBFCs will enable better price discovery, lower capital requirement, and facilitate credit flow from the banks.” The proposal to interest rate derivative regulations, he thinks, will provide the desired boost to the “ultimate goal of developing a dynamic environment for management of interest rate risk.”
The RBI had projected the GDP growth for 2018-19 in the December policy at 7.4%, with a higher rate of growth in the first half than the second. The CSO had estimated overall GDP growth at 7.2% for 2018-19.
RBI projected GDP growth for FY2020 at 7.4%, with a growth rate of 7.2-7.4% between April and September, and 7.5% in the final quarter, i.e., January-March.
Slowing global economy and exports
The MPC, however, noted that in spite of soft crude oil prices and the lagged impact of the recent depreciation of the Indian rupee on net exports, slowing global demand 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 uncertainties.
The six-member MPC, headed by Das, also noted that the output gap has opened up modestly as actual output has dipped lower than potential. Import growth had turned slow in November and turned negative in December 2018. Export growth was almost flat in November and December 2018 when compared on a year-on-year (YoY) basis.
Inflation and growth
For the first time in the current financial year, changes were made to the repo rate, after a prolonged period of caution. The key lending rate has been reduced, with the 6 members of the MPC voting 4:2 in of the rate cut.
Of the six-member panel, Ravindra H Dholakia, Pami Dua, Michael Debabrata Patra Shaktikanta Das voted in of the reduction in rate cut. Chetan Ghate and Viral Acharya voted to keep the policy rate unchanged.
The MPC expects headline inflation to remain soft in the near term. The rate cuts have been buoyed by optimistic trends and the hope that inflation will stay within its target range of 4%, “within a band of +/- 2%, while supporting growth,” said the RBI.
Retail inflation, measured in terms of the year-on-year change in the consumer price index (CPI), declined from 3.4% in October 2018 to 2.2% in December, the lowest in the last 18 months. The short-term outlook for food inflation “appears particularly benign”.
With its change in the monetary policy stance to neutral and the downward revision in inflation forecasts, the RBI is clearly focused on driving growth. All members unanimously agreed to relaxing the stance from “calibrated tightening.” This will help boost credit flow and also drive consumption.
How this might affect you: The changes to developmental and regulatory policies further reflect the growth orientation. Raising the limit of collateral-free agriculture loan from Rs 1 lakh to Rs 1.6 lakh, for example, will help small and marginal farmers access more credit within the formal financial system.
On insolvency and bankruptcy
Other commendable decisions include opening up the External Commercial Borrowings (ECB) route for applicants under the Insolvency and Bankruptcy Board (IBC) which will facilitate a faster turnaround.
How this might affect you: An umbrella body will also be set up for urban non-cooperative banks at state levels to ensure that account holders and depositors are protected. Such boards of management will further help revive the sector by strengthening the co-operative structure and expanding its reach.
Repo rate cut and investment
In terms of investment, the MPC document noted that activity was recovering, supported by public spending on infrastructure.
How this might affect you: On the plank of the 0.25% cut in repo rate, it recommends strengthening private investment activity and buttressing private consumption. So, this announcement is a way of complementing the Union Interim Budget’s 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 also 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.
Thus, low interests on lending is good news for homeowners with mortgages, as they would eventually have to pay lower monthly installments for their loans.
Consumption and investment activity will definitely witness a boost, while the rate cut will also lower developers’ working capital cost and the cost of borrowing for the banks.
But this is especially great for the real estate sector, which received a Budget bonanza last week, with tax scrapped from notional rent on the second self-occupied property and enabling the capital gains to be invested in two houses instead of one. With the interest in the real estate shooting up since then, the RBI’s segway to reduce the repo rate by 25 bps to 6.25 percent will provide a further bump to the industry.
While the key lending rates (repo and reverse repo rates) were adjusted, the marginal standing facility rate and the bank rate have been kept at 6.5 percent.
The next meeting of the MPC is scheduled from April 2 to 4.
Prarthana Mitra is a staff writer at Qrius