In line with market expectations, the RBI’s Monetary Policy Committee reduced its benchmark repo rate by 25 bps to 6.00% at its first policy review of FY20.

Key forecasts: On inflation, the central bank has lowered its CPI inflation trajectory across its forecast horizon, while on growth, it also cut its FY20 GDP growth forecast to 7.2% from 7.4%.

The RBI expects forecast risks for growth and inflation to be evenly balanced.Rationale for forecasts: The downward revision to the CPI inflation trajectory reflects the impact of substantial softness in food inflation in recent months. The overall comfort got reinforced by the recent spate of disinflation observed in key non-oil fuel items such as LPG, electricity, coke, firewood, and dung cake. In addition, the RBI trimmed its growth forecast for FY20 and expects output gap to be negative, there is a likelihood of incorporation of somewhat lower demand side price pressures in the coming quarters.

Our take: There are two critical takeaways from RBI’s forecast revisions. First, for the second time in a row, the RBI is expecting four consecutive quarters of below target inflation outcome. Second, on an average basis, the RBI expects inflation to be marginally lower in FY20 at 3.3% from 3.4% in FY19 — incidentally, this would be the lowest average annual inflation in India since FY91.

This indeed provided room for the central bank to opt for incremental monetary accommodation. Factors like moderation in inflation expectation of households and producers, persistence of the negative output gap, and a dovish turn from the US Fed and the ECB provided further support.

As an extension, one might wonder, if the projected inflation trajectory is extremely benign, then why did the MPC stop at just one rate cut? Given that the economy is facing growth headwinds from the global side and there is a “need to strengthen domestic growth impulses by spurring private investment”, a larger dose of monetary accommodation could have been justified.

It appears that the following considerations could have weighed against aggressive monetary easing:

Preliminary observations by weather agencies across the world suggest some likelihood of El Nino-related disturbance to India’s monsoon outlook. India’s private weather forecaster Skymet released its early forecast for the June-September 2019 monsoon season, as per which rainfall outturn is expected to be below normal at 93% (of long period average).

There is considerable uncertainty on the outlook for crude oil and international trade

Meanwhile, the fiscal consolidation process is undergoing a pause even as the quality of fiscal adjustment is set for some deterioration amidst the roll out of consumption stimulus
These uncertainties would keep the MPC under a data dependent mode with stance of policy neutrality according it the flexibility to provide incremental need based accommodation if the above mentioned inflation risks do not play out. Meanwhile, the RBI has been emphasising upon monetary transmission.

In this context, the infusion of primary liquidity via OMO purchases (`2,985 bn) and FX Swap ($5 bn) in FY19 along with the announcement of another $5 bn FX Swap (scheduled later this month) is a step in right direction. By allowing banks to reckon an additional 2% of g-secs within the mandatory SLR requirement as FALLCR for the purpose of computing LCR (in a phased manner) will not only enable effective management of liquidity by bank balance sheets, but it would also raise potential lending capability of banks, thereby supporting flow of funds to the economy.

While we are on the same page as the central bank on growth projection for FY20, we expect CPI inflation to be somewhat higher at 3.8% (nevertheless, below target) on account of lower horticulture production and reversal of the extremely soft food inflation regime (March 2019 mandi prices are pointing towards a sizeable jump in prices of key perishables). This is likely to result in a prolonged monetary pause.

However, this could be a close call if growth momentum were to slow down more than expectation, or upside risk to inflation fail to play out. In such an event, the chance of another 25 bps rate cut by August 2019 cannot be ruled out.
The author is chief economist, Yes Bank