The MPC’s acknowledgement of the need to address the slowing growth strengthens the case for another cut
The Monetary Policy Committee’s (MPC) accommodative policy stance amid a benign growth-inflation outlook has strengthened our case for another 25 bps cut in August. Rate cuts beyond August would, however, hinge on any downward surprises to the RBI’s growth-inflation trajectory. Our inflation trajectory in 2HFY20 remains slightly higher than that of RBI’s, which could limit rate cuts beyond August. However, the RBI’s focus on growth will likely come from ensuring adequate monetary transmission henceforth.
Repo rate cut by 25 bps to 5.75%
The MPC, expectedly, cut the repo rate by 25 bps to 5.75% and changed its stance to ‘accommodative’ from ‘neutral’. The decision to cut rates and change the stance this time was unanimous, as against (4,2) in favour of a rate cut and (5,1) in favour of retaining the ‘neutral’ stance in the last meeting. Besides rates, certain other decisions of note are: reviewing the liquidity management framework by constituting an Internal Working Group, which will submit its report by July, and moving further towards Basel III Standards by setting minimum leverage ratio at 4% for Domestic Systemically Important Banks (DSIBs).
MPC expects FY2020 CPI inflation to remain manageable
Even though the MPC believes that the recent pickup in food prices has imparted an upward bias to the inflation trajectory, subdued global and domestic demand will result in further softening of core inflation during FY2020, keeping the headline inflation broadly in check. The MPC now expects 1HFY20 CPI inflation at 3.0-3.1% and 2HFY20 inflation at 3.4-3.7% with risks broadly balanced.
Focus on addressing growth
Given the benign inflation outlook, MPC’s focus remains on addressing tepid growth, after further opening of the output gap since the April meeting. It emphasised that ‘growth impulses have weakened significantly’ and ‘there is scope for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular, reinvigorate private investment activity’. Citing weak global demand, moderating investment and softening consumption (especially in rural areas), the MPC revised down its FY2020 growth expectations to 7%.
Another 25 bps cut in August likely
The MPC’s acknowledgement of the need to address the slowing growth on the back of muted headline inflation along with an accommodative stance strengthens our case for another 25 bps cut in August. However, the evolution of food inflation in 2HFY20 could provide some upside to MPC’s inflation forecasts, which could restrict further cuts beyond August. Besides rate cuts, the RBI is likely to focus on ensuring smoother monetary transmission to revive growth. The proposed working committee to review the liquidity management framework could look into the suitability of the operative rate being closer to reverse repo in an accommodative cycle and vice versa.
Kotak Economic Research