Sharply lowers inflation forecast after consistently undershooting estimates; slew of steps to boost capital inflows, credit growth
Indicating a greater willingness under new governor Shaktikanta Das to address the objective of growth while being tenacious to the inflation-targeting framework, the Reserve Bank of India (RBI) on Thursday unexpectedly lowered the repo rate by 25 bps to 6.25%, simultaneously enabling with a shift in the monetary policy stance to ‘neutral’ from
A 4-2 majority vote at the Monetary Policy Committee (MPC) preceded the rate call, while the change in stance was a unanimous decision of the committee — the MPC has markedly lowered its inflation forecasts through Q3YF20. At the post-policy media conference, Das hinted that further rate reductions might materialise in the cycle if inflation remained on the benign trajectory predicted and expressed an intent to coax banks on policy transmission.
The central bank also announced a slew of steps to boost capital flows to the financial system and the wider economy and making it easier for well-rated NBFCs to access credit. In signs of RBI/MPC policy line aligning itself more decisively with the government’s and that Das, a long-time finance-ministry bureaucrat before assuming governor’s role, is indeed putting his foot down, RBI raised the limit of collateral-free agriculture loans to Rs 1.6 lakh from the current Rs 1 lakh (an income support scheme costing Rs 95,000 through FY20 was announced for small and marginal farmers in the recent Budget). The sixth bimonthly review also allowed corporate resolution applicants under the government’s crown jewel Insolvency and Bankruptcy Code (IBC) to raise ECB funds to repay the rupee loans of the target companies.
RBI, however, also showed its regulatory rigour and obstinacy by ruling out any relaxation of the February 12, 2018, circular that mandates banks to refer any default case where they are unable to find resolution in six months to the IBC process. The circular, challenged at the Supreme Court, was a bone of contention between RBI under Urjit Patel and the government, with the latter and top-notch PSBs pitching for a relief to at least the power producers from its “stringent” provisions.
Finance minister Piyush Goyal said the latest policy action and other RBI steps would “give a boost to the economy, lead to affordable credit for small businesses, home buyers etc. and further boost employment opportunities. Economic affairs secretary Subhash Chandra Garg said, “It is a very balanced and pragmatic policy statement.” Industry body CII said it is hopeful that “the rate easing cycle would continue going forward to provide a boost to demand at a time when inflation is down”.
Amid large outflows of portfolio funds from the Indian debt market, the RBI sought to arrest this trend by removing the rule that said a foreign portfolio investor (FPI) should not have exposure of more than 20% of its corporate bond portfolio in a single corporate. This could give the much-needed leeway to many investors and possibly spur inflows.
Bonds rallied on Thursday with the yield on the old benchmark bond — the 7.17% yielding notes maturing in 2028 — falling as much as nine basis points during the day, but experts sounded a note of caution on the fiscal front and felt the cycle might remain shallow. The Sensex and Nifty ended flat.
Helped by persistent deflation in major constituents of the food basket, retail inflation fell to an 18-month blow of 2.2% in December, while the core inflation (excluding food and fuel) remained somewhat sticky at 5.7%. Taking into consideration the benign short-term outlook for food inflation, dissipated effect of HRA increase for central government employees, moderation in household inflation expectations (down a seminal 130 bps for a 12-month-ahead horizon), and assuming a normal monsoon in 2019, the MPC has projected retail inflation at 2.8% for the current quarter.
Further, it substantially lowering the forecast to 3.2-3.4% range for H1FY20 from 3.8-4.2% previously and expecting a rate of 3.9% for Q3FY20. The unexpected 25-bps cut in policy rate temporarily puts to rest the debate on whether higher core inflation would guide the MPC’s decisions even as it is mandated to target only headline retail inflation at 4% (-/+ 2%). In fact, the policy document goes on to describe the ‘unusual’ uptick in health and education, which too are responsible for elevated core inflation, as a one-off phenomenon. Retail inflation has remained below the RBI’s medium-term target of 4% for five consecutive months through December.
While headline retail inflation is projected to remain soft in the near term, beyond this period, a host of uncertainties loom and an unusual spike in heath end education prices necessitated close monitoring, the MPC felt. While the MPC observed that the steps taken in the Budget could bolster aggregate demand by raising disposable incomes, its impact would be felt over a period of time, Das said “the impact of the budget proposals (which, with sizeable off-balance sheet borrowings, could prove to be expansionary) have been factored in”. On extra-budgetary borrowings, he said it was “for the fiscal administrators to take a call”on them.
The MPC projected a 7.4% real GDP expansion for the next fiscal year, while lowering its forecast for the first half to 7.2-7.4% for against 7.5% as stated in the December policy. The committee noted that “the output gap had opened up modestly as actual output inched lower than potential.” While it alluded to a recovery in investment activity, it added this was largely supported by public spending on infrastructure, while highlighting the need to strengthen private investment activity and support private consumption.
While the central bank announced OMO purchase schedule of Rs 37,000 crore for February, the average daily liquidity position has turned into surplus of late. Banking system liquidity moved into a surplus of Rs 50,000 crore as on February 4.
The governor said further liquidity infusion would depend on the evolving situation, an assessment for which is being made on a weekly basis. Via the open market operations (OMO) route, the RBI has injected durable liquidity of Rs 2.36 lakh crore so far in the current financial year.