Monetary Policy: MPC Springs Surprise With 35-Basis-Point Rate Cut

India’s Monetary Policy Committee cut its benchmark interest rate for the fourth time this year -- this time by 35 basis points -- to support growth in the economy at a time when inflation remains in check. Addressing growth concerns assumes the "highest priority" at this juncture, the MPC said while maintaining an "accommodative" monetary policy stance.

Following Wednesday's review, the repo rate stands reduced by 35 basis points to 5.4 percent, taking the total quantum of rate cuts in 2019 to 110 basis points. At current levels, the repo rate is at its lowest since 2010 and the rate cutting cycle has been the steepest since 2015-16, when Raghuram Rajan cut rates by 125 basis points.

A majority of the 36 economists polled by Bloomberg had forecast a 25 basis point cut. Bank of America-Merrill Lynch had forecast a 35 bps cut in rates.

The benign outlook for inflation allows headroom for policy action to close the "negative output gap", the MPC said in its statement.

"Even as past rate cuts are being gradually transmitted to the real economy, the benign inflation outlook provides headroom for policy action to close the negative output gap. Addressing growth concerns by boosting aggregate demand, especially private investment, assumes the highest priority at this juncture while remaining consistent with the inflation mandate," the MPC said.

The committee also pared its expectation for growth in FY20 to 6.9 percent from 7 percent earlier.

"Various high frequency indicators suggest weakening of both domestic and external demand conditions," the MPC said while adding that monetary policy actions taken since February will aid growth going forward.

In the press briefing after the MPC announcement, the RBI Governor said that interactions with various stakeholders including public and private sector banks indicate that steps are being taken by them to progressively lower their interest rates so that the benefit of policy rate reductions are passed on to the economy. “Accordingly we expect higher transmission of monetary policy action and stance by the banks in the weeks and months again."

Key Highlights

• MPC cuts repo rate by 35 bps to 5.40 percent
• MPC maintains 'accomodative' monetary policy stance
• Four members of MPC voted for a 35 bps cut; 2 voted for a 25 bps cuts
• RBI cuts FY20 GDP growth forecast to 6.9 percent from 7.2 percent earlier
• RBI pegs H2 FY20 inflation at 3.5-3.7 percent
• RBI cuts risk weight for consumer credit from 125 percent to 100 percent, except for credit card receivables
• Exposure limit for single NBFC raised to 20 percent from 15 percent
• Bank lending to NBFCs for agri and SME loans eligible for priority sector classification

The Economic Backdrop

GDP growth fell to 5.8 percent in the fourth quarter of 2018-19 and is seen slipping further in the first quarter of 2019-20. SBI Economic Research expects GDP growth to fall to 5.6 percent in the April-June 2019 period and to 6.5 percent in FY20.

To be sure, economists now see part of the slowdown as structural, which would limit the impact of counter-cylical policies such as lower interest rates.

Still, with inflation under check, the MPC had room to reduce interest rates.

The MPC's inflation forecast for the second half of the year was revised marginally from 3.4-2.7 percent to 3.5-3.7 percent. CPI inflation for Q1 2020-21 is projected at 3.6 percent. The inflation outlook will be guided by several factors, the committee said.

While higher food inflation may sustain, "the outlook for CPI inflation excluding food and fuel remains soft," the MPC said.

At 3.18 percent, CPI Inflation remains well below the mid-point of the MPC’s target of 4 (+/- 2) percent. While inflation in the food and beverages category has risen in recent months, core inflation has fallen to 4.09 percent, reflecting weak consumer demand.

The MPC’s latest rate cut comes against the backdrop of global monetary policy easing. The US Federal Reserve cut interest rates by 25 basis points earlier this month as an “insurance” against economic weakness that may be brought on by global trade tensions. Central banks in Asia, too, are expected to easy monetary policy to protect against weaker global growth at a time when inflation remains subdued world-over.

Easing Flow Of Credit

The RBI, separately, also announced a series of measures to improve credit flow. In particular, the regulator reduced the risk weight for consumer credit across most categories, excluding credit card receivables.

• The risk weight for all consumer credit categories has been cut to 100 percent from 125 percent earlier. This excludes credit card receivables
• The exposure limit for single NBFCs has been raised to 20 percent from 15 percent earlier.
• Bank lending to NBFCs for agriculture and SME lending will be eligible for priority sector lending, the RBI said.

Market Reaction

Bond and equity markets were at first mostly unmoved by the cut. The 10 year sovereign bond yield dropped two basis points to 6.31 percent within minutes of the announcement but has since spiked to 6.35 percent on comments from the RBI Governor. The rupee held on to 70.93 before rising to 70.84, whereas the benchmark Nifty 50 index slipped by 15 points before recovering to trade marginally in the green. The Nifty Bank index gained 0.5 percent.

Yields may have spiked today due to the RBI Governor’s commentary that further rate cuts to be calibrated, Shubhada Rao, group president and chief economist at Yes Bank, said to BloombergQuint.

By saying that 50 bps was excessive, the market was disappointed because it was expecting around 50 bps, said Jayesh Mehta, managing director and country treasurer at Bank of America. “The way the current globe and the local economy is going, I think we needed dramatic deep downs. But I would expect the effective rate going down to 5 percent in the next 6 months or so.”

Watch the MPC announcement and RBI Governor Shaktikanta Das’ press briefing here.