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RBI Policy | Stance to stay accommodative as long as output gap is negative

One more rate cut will depend on how quickly inflation appears to be reverting back towards 4 percent.

February 06, 2020 / 06:10 PM IST
LIVE updates of the Reserve Bank of India (RBI)'s Monetary Policy Committee (MPC) decisions

LIVE updates of the Reserve Bank of India (RBI)'s Monetary Policy Committee (MPC) decisions

Aditi Nayar

Along the expected lines, the Monetary Policy Committee (MPC) kept the repo rate unchanged at 5.15 percent in the February 2020 policy review, in a unanimous decision, balancing the onion price-led spike in headline inflation with economic growth that remains in doldrums.

The committee highlighted that the inflation outlook is highly uncertain and indicated that it will remain vigilant about the risks of generalisation of inflationary pressures. However, in spite of the headline inflation having breached the upper threshold of the MPC's medium-term target of 6 percent in December 2019, the reiteration that policy space is available for future action and the accommodative stance will be maintained for as long as necessary to revive growth lent a distinctly dovish tilt to the policy statement.

The surge in the CPI (consumer price index) inflation to 7.4 percent in December 2019 was led by unseasonably high vegetable prices, which would largely normalise in the ongoing quarter, with improved domestic supplies and imports, as well as firming up of prices of protein items, oils and cereals, which could remain sticky. Other inflation risks include the volatility in crude oil prices, increase in input costs of services, mobile phone charges, and drugs and pharmaceuticals, higher customs duty and the like.

Importantly, households’ inflation expectations moderated in the January 2020 round of the survey conducted by the RBI, which probably reflects some correction in vegetable prices. This should potentially be mirrored in some easing in the CPI inflation print for January, which will be released next week.


The MPC has placed its CPI inflation projection for Q4 2019-20 at 6.5 percent, substantially higher than its December 2019 forecast of 5.1-4.7 percent for H2 2019-20, with risks broadly balanced. Moreover, it has considerably revised its CPI inflation forecast for H1 2020-21 to 5.4-5 percent from its December 2019 forecast of 4-3.8 percent, with risks broadly balanced. This is expected to be followed by a base effect-led fall in retail inflation to 3.2 percent in Q3 FY21.

The MPC has projected a pick-up in GDP (gross domestic product) growth to 6 percent for FY21 (from 5 percent in FY20), which is in line with our estimate. The growth projection for H1 FY21 has been lowered to 5.5-6 percent from the forecast of 5.9-6.3 percent in the December policy review, and placed at 6.2 percent for Q3 FY21. We concur with the committee’s assessment that the upturn in some lead indicators is yet to become broad-based.

Going forward, we anticipate that the stance of the monetary policy will be retained as accommodative as long as the MPC perceives the output gap to be negative, regardless of the level of inflation. Accordingly, we no longer expect the stance to be changed to neutral in the next few policies.

Moreover, the statement suggests the near certainty of at least one further rate cut. The timing of the same will depend on how quickly inflation appears to be reverting back towards 4 percent. As of now, we expect a rate cut to be announced in the August 2020 policy, with a small chance that it would be pre-empted in the June review.

However, we continue to expect the magnitude of further monetary easing to be limited. Even with a favourable base effect, the committee is projecting the CPI inflation to recede only to 3.2 percent in Q3 FY21, which is just mildly lower than the actual print of 3.3 percent in H1 FY20.

In the meantime, we expect that further sector-specific measures may be announced by the central bank, aimed at spurring growth and removing constraints in specific stressed sectors, along with a continued push to improving the transmission of the 135 bps of rate cuts in 2019.

Aditi Nayar is Principal Economist, ICRA. Views are personal.
Moneycontrol Contributor
first published: Feb 6, 2020 06:10 pm

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