RBI cuts policy rate by 25 basis points, keeps CRR unchanged

The Reserve Bank of India (RBI) on April 4 lowered the repo rate—its key lending rate—by 0.25 percentage points to 6 percent, but retained its stance at "neutral", hinting that the economy may have entered a slowdown mode amid scattered signs of weakening investment activity.

It struck a somewhat bearish note about the broader economy's prospects, particularly in the short term, revising GDP growth projections for 2019-20 to 7.2 percent from 7.4 percent it had forecast in February.

The economy will likely grow in the range of 6.8-7.1 percent in April-September 2019, from 7.2-7.4 percent projected earlier, but is expected to gather pace thereafter, with the central estimating that GDP will grow at 7.3-7.4 percent October-March.

The lower repo rate—the rate at which banks borrow from the RBI— has raised hopes of bringing down EMIs for the millions of home loan borrowers as well cut capital raising costs for corporates, with banks expected to pass on the reduced rates by slashing lending rates for its customers.

However, due to tight liquidity conditions, banks may not be able to pass on the benefit to the borrowers.

The six member Monetary Policy Committee (MPC), headed by RBI Governor Shaktikanta Das, noted that inflation remains firmly within the comfortable range and will likely persist below 4 percent throughout 2019-20.

"Assuming a normal monsoon in 2019, the path of consumer price index (CPI) inflation is revised downwards to 2.9-3.0 percent in April-September 2019-20 and 3.5-3.8 per cent in October-March 2019-20, with risks broadly balanced," the monetary policy statement said.

Das told journalists after presenting the policy that while banks have cut the marginal cost of lending rate (MCLR), lenders definitely needed to do more for stronger monetary transmission, the extent to which lenders have passed on lower repo rates to its customers.

In December, it had 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.

On April 4, the RBI announced that more consultations were required for moving into a new interest rate benchmarking system.

"Taking into account the feedback received during discussions held with stakeholders on issues such as (i) management of interest rate risk by banks from fixed interest rate linked liabilities against floating interest rate linked assets and the related difficulties, and (ii) the lead time required for IT system upgradation, it has been decided to hold further consultations with stakeholders and work out an effective mechanism for transmission of rates," RBI said.

On the real sector, there are, however, signs that of sluggish investment. "There are some signs of domestic investment activity weakening as reflected in a slowdown in production and imports of capital goods. The moderation of growth in the global economy might impact India’s exports," the central bank said.

That said, household spending holds out promise to spur growth in the broader economy, buoyed by tax benefits and greater spending ability.

"Private consumption, which has remained resilient, is also expected to get a fillip from public spending in rural areas and an increase in disposable incomes of households due to tax benefits. Business expectations continue to be optimistic," it said.

There are, however, few worry lines hovering on the price front, including uncertainty over summer rains. Early reports suggest a higher probability of El Nino effects in 2019, which could result in scanty monsoon rains in India.

El Nino – or "the boy child" in Spanish – is a weather phenomenon characterised by an abnormal warming of the eastern Pacific Ocean that triggers weaker rains and droughts in the Indian sub-continent.

According to the National Oceanic and Atmospheric Administration (NOAA) of the US, El Niño conditions strengthened during February 2019, which may affect the prospects of a normal south west monsoon.

The south west monsoon is lifeblood of India's agriculture. It is critical to replenish 81 reservoirs necessary for power generation, irrigation and drinking. About half of India's farm output comes from summer sown kharif crops such as rice, sugar, cotton, coarse cereals.

Abundant rains can push up rural spending on several items such as televisions, cars and gold. Conversely, below normal monsoon can negatively impact the broader economy.

"There is also the risk of an abrupt reversal in vegetable prices, especially during the summer months," said RBI.

Also, the outlook for oil prices "continues to be hazy, both on the upside and the downside. On the one hand, continuing OPEC (Organisation Petroleum Exporting Countries, a cartel of oil producers) production cuts will reduce supplies. On the other hand, there is considerable uncertainty about demand conditions," it said.

An early resolution of trade tensions, particularly between the US and China, and resultant a pick-up in global growth, will push up demand for oil, raising crude oil prices.

"However, should trade tensions linger and demand conditions worsen, crude prices may fall from current levels, despite production cuts by OPEC," it said.

India’s retail inflation stood at 2.57 percent in February 2019, compared to 1.97 percent in the previous month and 4.44 percent in the February 2018

The RBI, however, cautioned that inflation excluding food and fuel has remained elevated over the past twelve months with some pick up in prices in February.

"Should the recent slowdown in domestic economic activity accentuate, it may have a bearing on the outlook for inflation in this category," it said.

Volatile global financial markets and trade uncertainty also may have an influence on the inflation outlook. Besides, "the fiscal situation at the general government level requires careful monitoring," it said.

Pami Dua, Ravindra H. Dholakia, Michael Debabrata Patra and Shaktikanta Das voted in favour of the decision to reduce the policy repo rate by 25 basis points. Chetan Ghate and Viral V. Acharya voted to keep the policy rate unchanged.

On stance, Ghate, Dua, Patra, Acharya and Das voted in favour of the decision to maintain the neutral stance of monetary policy. Dholakia voted to change the stance from neutral to accommodative.