Monday, February 11, 2019

RBI’s February Rate Cut—Surprising or not so.....

In an interesting move, unexpected by many, in the February 2019 policy review the RBI decided to change the stance of monetary policy from calibrated tightening to neutral and to reduce the policy repo rate by 25 basis points to 6.25 percent with a 4:2 majority vote. Consequently, the reverse repo rate under the LAF stands adjusted to 6.0%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.5%. Repo is the rate at which RBI lends to commercial banks, whereas reverse repo is the short-term borrowing rate at which the central bank borrows from other banks. The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate below which a bank is not permitted to lend, barring a few exceptional cases permitted by RBI.
This is the first rate cut announced by the MPC since August 2017 and marks a reversal in the rate cycle. Over the course of 2018, the MPC had raised rates twice by a total of 50 basis points to 6.5 percent.

In October, RBI had changed the policy stance to ‘calibrated tightening’ from neutral fearing that elevated core inflation poses upside risks to headline inflation. The shift in stance of monetary policy from calibrated tightening to neutral provides flexibility and the room to address the challenges to sustain growth of the Indian economy, as long as the inflation outlook remains benign, according to the latest policy announcement. The decisions of the MPC in this regard will be data driven and in consonance with the primary objective of monetary policy to maintain price stability.

The rate cut was not anticipated by a majority because it was against the RBI policy if inflation management and came at a time when there was no major downturn in growth, at least according to official data. Though headline inflation has softened considerably, the rate cut was a surprise given that the softening was mostly on account of the volatile food and fuel items, which showed a deflationary trend and expectations mostly in line with global cues as also seasonal factors. Any abatement in global trade tensions and already dovish US policy could well change inflationary expectations. Further, as per government statements the Indian economy is recording stellar performance which dilutes the need for a rate cut, particularly at a time when an expansionary budget had just been unveiled. The change of stance which implies from hawkish to neutral was expected, however, the dovish rate action caught analysts unawares, as it puts the central bank’s credibility at stake with doubts already hovering on the fiscal roadmap of the government.

The move, however, is not so surprising if one goes by a combination of factors mentioned by the RBI in its assessment and outlook, such as the slowdown in both external and domestic demand, weaker flows from institutional investors, borrowing costs remaining elevated, as well as a jobs report and higher frequency indicators showing signs of an economic slowdown. The statement on developmental and regulatory policies also reflects growth orientation. The highlight is the enhancement of the limit of collateral-free agriculture loan to Rs.1.60 lakh, to bring more farmers within the formal credit system. Neither is it surprising when one considers that in an election year, with the government unable to announce any measures for Industry in its February Budget presentation, the long standing demand for a rate cut should be met, given the change at the helm of RBI.

With the inflationary Interim budget and monetary policy being announced in tandem in the election year it will be interesting to see the stance and rate decisions in the subsequent monetary policies as inflation dynamics play out, particularly as core inflation, which is now a global benchmark has remained sticky, still hovering around near.6 percent.

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