RBI policy: MPC keeps repo rate unchanged at 6.50%

The Reserve Bank of India (RBI) on December 5 kept the repo rate — its key lending rate — unchanged at 6.5 percent, but left the door ajar for reducing loan rates in the coming months if low inflation rates were to persist long enough.

The central bank also sounded bullish about the prospects in the real sector, retaining its 2018-19 GDP growth forecast at 7.4 percent amid strong investment revival signs.

It introduced a new method for fixing floating loan charges—a move that will likely force banks to change home loan rates according to the way the RBI’s repo rate or government bond yields move.

The statutory liquidity ratio (SLR)—the portion of deposits banks have to set aside in government bonds, gold, and cash—will be also progressively reduced to 18 percent from 19.5 percent currently, with a 0.25 percentage point reduction every quarter beginning January 2019.

This will likely shore up the banks’ pool of lendable resources for individuals and corporations.

The rural economy, however, remains a worry with farms reporting lower sowing for the rabi( winter-sown) crop, nipped by patchy soil moisture because of a scanty monsoon this year.

The six-member monetary policy committee (MPC), headed by RBI governor Urjit Patel, expected retail inflation to moderate to 2.7-3.2 percent during October-March this year, before rising to 3.8-4.2 percent in April-September in 2019-20, with “risks tilted towards the upside.”

India’s retail inflation eased at 3.31 percent in October, lowest in a year, as compared with 3.70 percent in September, driven by cheaper food items.

Crude oil prices have also moderated sharply over the last six weeks, which could push down headline inflation rate even further. This could allow the RBI more elbow room to lower lending rates, eventually bringing down borrowing costs for individuals and corporates.

“There is space for commensurate policy action if the upside inflation risks don’t materialise,” Patel told journalists in a news conference after the policy announcement.

“Need few more data points to ascertain the durability of the decline in inflation…We will take a call as and when is required,” Patel said.

Patel, however, refused to take questions on the recent standoff with the government, including issues relation to Section 7 of the RBI Act that allows the government to push RBI to take certain decisions.

Deputy governor Viral Acharya, whose recent speech flagging the need to maintain RBI’s autonomy had marked the turning point in a simmering government versus RBI dispute, said that the central bank will always stand by as the lender of last resort if conditions necessitate such a move.

The MPC, however, retained the monetary policy stance at “calibrated tightening,” implying that the central bank’s focus remains steadfastly focussed on taming inflation, even if it comes at the cost of higher rates.

The MPC noted that the benign outlook for headline inflation is driven mainly by the unexpected softening of food inflation and collapse in oil prices in a relatively short period.

Excluding food items, inflation has remained sticky and elevated, and the output gap remains virtually closed. The output gap is the difference between the actual output of an economy and its potential output or the maximum amount of goods and services an economy can turn out when it is most efficient—that is, at full capacity.

The MPC also noted that even as escalating trade tensions, tightening of global financial conditions and slowing down of global demand pose some downside risks to the domestic economy, the decline in oil prices in recent weeks, if sustained, will provide tailwinds.

“The acceleration in investment activity also bodes well for the medium-term growth potential of the economy,” it said.

The RBI also obliquely asked the government to stick to its fiscal deficit target, to ensure that extra government borrowing doesn’t crowd out funds needed for private investment needs.

“The time is apposite to further strengthen domestic macroeconomic fundamentals. In this context, fiscal discipline is critical to create space for and crowd in private investment activity,” the monetary policy statement said.

The RBI’s own surveys showed that companies are adding more capacities to cater to extra demand for their goods, a sign that bodes well for the broader economy that has been buffeted by a shaky rural sector and mixed signals from the services industries.

Capacity utilisation (CU), measured by the Reserve Bank’s Order Books, Inventories and Capacity Utilisation Survey (OBICUS), increased from 73.8 per cent in April-June to 76.1 per cent in July-September, which was higher than the long-term average of 74.9 per cent. Seasonally adjusted CU also increased to 76.4 per cent.

“Available high frequency indicators suggest that industrial activity has been improving in Q3 (October-December). The growth in core industries recovered in October on the back of double-digit expansion in coal, cement and electricity,” the statement said.

The purchasing managers’ index (PMI) for manufacturing touched an eleven-month high of 54.0 in November, supported by an expansion in output, and domestic and export orders.

“According to the assessment of the Reserve Bank’s Industrial Outlook Survey (IOS), the overall business sentiment in October-December remained stable, with sustained optimism about production and exports,” the statement said.