RBI cuts repo rate by 25 bps: Industrial outlook bearish, low inflation could be transient

Gaurav Choudhury and Beena Parmar

The Reserve Bank of India (RBI) on Wednesday cut its key lending rate —the repo rate — by 25 basis points (0.25 percentage points) to 6 percent, triggering hopes of lower borrowing costs for households and companies ahead of the festival season.

Markets were, however, lukewarm, with stock indices slipping into the red within minutes of the announcement, mirroring a sense of feeling let down that the rate was not cut by 50 basis points, given record low inflation levels.

The six member monetary policy committee (MPC), headed by new RBI governor Urjit Patel, were of the view that the moderation in price trends have persisted long enough to warrant lower loan costs, necessary to engineer a quick industrial turnaround and goad people to spend more.

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That said, the MPC hinted about lurking inflation risks in the near to medium term. It also flagged concerns about the deceleration in services and industry, placing the onus on the Centre and state governments to hasten project approvals and aid private investment.

Inflation rates have slowed to record lows and food prices have been falling. Consumer price index (CPI) — commonly referred to as retail inflation that the RBI tracks — moderated sharply to 1.54 percent in June, the lowest since the index was rebased to 2012 in a new data series.

“The trajectory of inflation in the baseline projection is expected to rise from current lows, the MPC decided to keep the policy stance neutral and to watch incoming data. The MPC remains focused on its commitment to keeping headline inflation close to 4 percent on a durable basis,” the RBI said in a statement.

The RBI and the government have set a retail inflation target of 4 percent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 percent.

While inflation has fallen to a historic low, a conclusive segregation of transitory and structural factors driving the disinflation is still elusive. “The MPC will continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway,” it said.

The panel also maintained a “neutral” stance, meaning a chance of rate cut in the near future would be data driven.

Persistently low inflation levels can indicate poor demand and weak economic activity, and it was widely expected that the central bank will cut interest rates to prod spending and investment.

“There is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all. This hinges on speedier clearance of projects by the states,” the statement said.

The MPC seemed acutely aware that mounting corporate bad debt should not slow down loans to productive sectors showing revival signs.

The unexpected surge in demonetisation-induced liquidity, and the subsequent flight out of funds from bank accounts has upset many banks’ asset-liability math.

Only two days ago, State Bank of India (SBI), the country’s largest bank, cut the interest rate on savings accounts with balance of up to Rs 1 crore by 50 basis points to 3.5 percent, citing falling inflation rates and high high real interest rates as the main reasons behind the move.

SBI has argued that its incremental cost of funds was going up as 60 percent of demonetisation deposits have flowed out.

“New lending transmission has been much stronger. Given the liquidity conditions prevailing, there is scope for banks to cut rates further,” Patel said in a post-policy press conference.

Three MPC members—Pami Dua, Viral Acharya and Urjit Patel—favoured a 25 basis point repo rate cut, while Ravindra Dholakia voted for a policy rate cut of 50 basis points. Michael Debabrata Patra voted for a status quo.

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The government and the RBI are working in close coordination to resolve large stressed corporate borrowers and recapitalise public sector banks within the fiscal deficit target. These efforts should help restart credit flows to the productive sectors as demand revives, it said.

A new law empowers the Reserve Bank of India (RBI) and banks to initiate bankruptcy proceedings against chronic defaulters.

In June, the Reserve Bank of India (RBI) said that it had identified 12 accounts totaling about 25 per cent of the current gross non-performing assets (NPAs) of the banking system for immediate reference under Insolvency and Bankruptcy Code (IBC).

The MPC was of the view that the industry and services were in a spot of bother. “In its assessment of real activity, the MPC noted that while the outlook for agriculture appears robust, underlying growth impulses in industry and services are weakening, given corporate deleveraging and the retrenchment of investment demand”.

Business sentiment has muted with a central bank conducted poll reflecting moderation of expectation in the manufacturing sector in the second quarter, compared to the previous quarter. New investments have also fallen to a 12-year low in April-June.

Moreover, high levels of stress in twin balance sheets – banks and corporations – are likely to deter new investment. With the real estate sector coming under the regulatory umbrella, new project launches may involve extended gestations, and along with the anticipated consolidation in the sector, may restrain growth, with spillovers to construction and ancillary activities.

The spate of farm loan waivers will also likely have decelerating effect on investment. “Given the limits on raising market borrowings and taxes by States, farm loan waivers are likely to compel a cutback on capital expenditure, with adverse implications for the already damped capex (capital expenditure) cycle,” the statement said.

Latest data show factories are barely producing more goods.  Factory output – a good indicator of both industrial activity and mood of shoppers – crawled at 1.7 percent in May. The manufacturing sector, which accounts for 75 percent of total factory output measured by the index of industrial production (IIP), fare even worse growing 1.2 percent during May.

According to the Nikkei India Manufacturing Purchasing Managers' Index (PMI), manufacturing activity in Indian factories slowed to an eight-year year low in July, partly pulled down by drop in new orders and output following the rollout of the goods and service tax (GST).

The PMI, a metric to measure industrial activity capturing output to sales, fell to 47.9 in July, from 50.3 in the previous month indicating faltering business conditions. A reading below 50 indicates contraction in factory output.

The 78th round of the Reserve Bank’s industrial outlook survey (IOS) revealed a waning of optimism in July-September about demand conditions across parameters, and especially on capacity utilisation, profit margins and employment, the statement said.