The Reserve Bank of India on Thursday cut the key interest rate by 25 basis points to 6.25% and shifted the policy stance to ‘neutral’ terming it a ‘decisive’ act to promote investment and consumption in an economy facing weak demand. The move may open the doors to a lower interest rate cycle based on receding inflation, though it could only be for a short term going by past trends. After claiming success in tackling price pressures since inflation targeting was adopted about two years ago, the Monetary Policy Committee voted unanimously on Thursday for a shift in stance to ‘neutral’ from ‘calibrated tightening’ and lowered inflation forecast.
The central bank also brought nonbanking finance companies (NBFCs) on a par with manufacturing companies with regard to capital requirements for banks that lend to them. The credit rating of an NBFC will now determine how much capital the bank has to set aside, making thousands of crores of rupees available for lending to a sector buffeted by concerns over liquidity.
“The favourable macroeconomic configuration that is evolving underscores the need to act now when it is most opportune,” RBI governor Shaktikanta Das told reporters. “It is vital to act decisively and timely to address the objective of growth once the objective of price stability has been achieved.” Markets reacted cautiously to the decision. The benchmark bond yield fell four basis points to close at 7.32% on Thursday pushing prices up. The unexpected rate cut could not trigger any big rally for bond traders amid worries over excess supply of paper. The rupee gained 11 paise or 0.14% against the dollar. The Sensex closed a tad lower at 36,971points, down four points. The six-member monetary policy committee (MPC) voted 4-2 in favour of a rate cut. The repo rate is the rate at which the RBI lends to banks.
“Governor Das’ remarks that there is room to cut suggests this is not a one and done easing,” said Radhika Rao, economist at DBS Bank. “A sharp revision in inflation outlook and limited spill-over seen from a slippage in fiscal targets paves the way for a shallow rate-cut cycle.” Food inflation has continued to surprise on the downside with continuing deflation across several items and a significant moderation in inflation in cereals. The RBI said the short-term outlook for food inflation looks benign despite adverse base effects and a sustained high core inflation, i.e., non-food and fuel prices.
“Food inflation has continued to surprise on the downside with continuing deflation across several items and a significant moderation in inflation in cereals,” said Das. “While inflation excluding food and fuel remains elevated, the recent unusual pick-up in the prices of health and education could be a one-off phenomenon.” Headline inflation is projected to remain soft in the near term, reflecting the current low level of inflation and the benign food inflation outlook.
RBI revised the consumer inflation forecast downwards to 2.8% in fourth quarter in FY19, from 2.7-3.2% in the last meeting. The projection for H1 in FY20 is at 3.2-3.4% with risks broadly balanced around the central trajectory. The consumer price index, the retail inflation gauge, dropped to 2.2% in December. The RBI’s inflation target is 4% with a band of 2 percentage points on either side.
‘BOOST TO AFFORDABLE CREDIT’
The government also welcomed the banking regulator’s move. “RBI’s decision to reduce the repo rate and change of stance to ‘neutral’ will give a boost to the economy, lead to affordable credit for small businesses and homebuyers, and further boost employment opportunities,” interim finance minister Piyush Goyal said in a tweet. The tweaking of capital adequacy norms to NBFCs could release capital for banks to lend to other sectors. “Assuming a 50% exposure of banks’ exposure to NBFCs in the other category (which were not risk weighted) and a 50% reduction in their risk-weights, the capital requirements of banks against these exposure can reduce by about Rs 12,500 crore, which in turn can be used for incremental lending or improvement their their capital ratios,” said ICRA.
About a third of 25 participants in an ET survey on interest rates had said that the MPC could slash rates by 25 bps, while the rest expected a pause. GDP growth for 2019-20 is projected at 7.4% — in the range of 7.2-7.4% in the first half, and 7.5% in the third quarter — with risks evenly balanced. While investors cheered the decision, some feared that the government’s fiscal deficit target of 3.4% for next fiscal was a bit too optimistic and the excess borrowing could lead to higher inflation. But Das said even that has been factored into the inflation forecasts.
The Economic Times, 08th February 2019
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