RBI cuts repo rate by 25 bps, raises hopes of further cuts; changes stance to ‘neutral’

The Reserve Bank of India (RBI) on February 7 lowered the repo rate—its key lending rate—by 0.25 percentage points to 6.25 percent and changed its stance to “neutral” from “calibrated tightening”, signalling higher chances of more cuts in the coming months if inflation persisted within tolerable limits.

The central bank also sounded bullish about the prospects in the real sector, only marginally reducing its 2019-20 GDP growth forecast to 7.4 percent from 7.5 percent earlier, amid sprouting investment revival signs.

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 to its customers.

The six-member Monetary Policy Committee (MPC), headed by RBI governor Shaktikanta Das, noted that large part of the current investment recovery has been driven by government spending and it was necessary to broad base the revival with a private sector boost.

RBI will meet banks in the next fortnight to discuss a range of issues, including the extent to which lenders have passed on lower repo rates to its customers, Das told journalists after presenting the policy.

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.

The RBI also announced a string of regulatory changes including raising the limit of collateral free bank loans for farmers to Rs 1.6 lakh from Rs 1 lakh currently, among others.

Banks have also been given greater operational freedom to offer interest rates to bulk deposits, raising the definition of “bulk deposits” to Rs 2 crore from Rs 1 crore currently.

“Investment activity is recovering but supported mainly by public spending on infrastructure. The need is to strengthen private investment activity and buttress private consumption,” the MPC statement said.

The focus will now shift to growth given the stability in inflation levels, said Das, who was presenting the monetary policy review after taking charge as RBI Governor in December.

There are few worry lines, both in the industrial sector, as well as the rural economy.

“First, aggregate bank credit and overall financial flows to the commercial sector continue to be strong, but are yet to be broad-based. Secondly, in spite of soft crude oil prices and the lagged impact of the recent depreciation of the Indian rupee on net exports, slowing global demand could pose headwinds. In particular, trade tensions and associated uncertainties appear to be moderating global growth,” Das said.

Rabi sowing so far (up to February 1, 2019) has been lower than in the previous year, but the overall shortfall of 4 percent across various crops is expected to catch up as the season comes to a close.

“The extended period of cold weather in this year’s winter is likely to boost wheat yields, which would partly offset the shortfall, if any, in area sown,” it said.

Headline inflation will likely persist within the RBI’s tolerable level of 4 percent. The RBI projected that consumer price inflation, the primary price gauge that it tracks for interest rate decisions, will be around 3.2-3.4 percent during April-September 2019, reflecting the current low inflation levels and benign food price outlook.

India’s retail inflation eased to an 18-month low of 2.19 percent in December, driven by cheaper food items.

Crude oil prices have also moderated sharply over the last six weeks, which could push down headline inflation rate even further. This could allow the RBI more elbow room to lower lending rates, eventually bringing down borrowing costs for individuals and corporate houses.

The RBI, however, said that “some uncertainties warrant careful monitoring”, flagging seven key issues.

These include the volatile vegetable prices that could reverse upwards, uncertainty in crude oil prices despite the drop in recent months, heightening global trade tensions, the unusual spike in health and education prices, volatility in financial markets, monsoon rains in the coming summer months and its impact on food prices, and lastly, the union budget proposals’ effect on the real sector.

“While inflation excluding food and rule remains elevated, the recent unusual pick-up in the prices of health and education could be a one-off phenomenon,” the statement said.

Inflation expectations, a broad measure of what businesses, investors and households think about how prices will change in the coming months, have softened by 80 basis points for the next three months and the 130 points in the next 12 months, according to the RBI’s latest survey in December 2018.

“Inflation in the prices of farm inputs and industrial raw materials remain elevated, despite some softening. Growth in rural wages moderated in October,” RBI said.
The decision to change the monetary policy stance was unanimous. Among the MPC members, Ravindra H. Dholakia, Pami Dua, Michael Debabrata Patra and Das voted in favour of a repo rate cut. Chetan Ghate and Viral V Acharya voted to keep the policy rate unchanged.

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