RBI surprisingly keeps interest rates on hold over rising inflation worries

The Reserve Bank of India sprang a surprise on Thursday, with the monetary policy committee (MPC) unexpectedly choosing to keep the repo rate on hold, even as it cut its GDP growth forecast sharply after the second-quarter GDP growth further slowed to 4.5 per cent.

The MPC maintained the repo rate—the benchmark rate at which the central bank lends to commercial banks—at 5.15 per cent and the reverse repo rate at 4.90 per cent. RBI Governor Shaktikanta Das insisted that it was only a temporary pause, taken to give more time for the measures taken by the government so far as well as the impact of the earlier interest rate cuts to play out.

“We want the earlier rate cut to play out fully. We can’t be sort of mechanically reducing the rate every time. We have to see that the rate cut whenever it is undertaken it is done in a manner that it has a maximum impact,” Das told reporters.

The central bank has reduced the repo rate by 135 basis points (bps) between February and October this year. However, the one-year median marginal cost of funds-based lending rate (MCLR) of banks has declined by only 49 bps. The weighted average lending rate on fresh rupee loans sanctioned by banks declined by only 44 bps.

Even in the money markets, while the transmission to various money and corporate debt market segments ranged from 137 bps to 218 bps, transmission to government securities (G-Sec) market was only partial at 113 bps for five-year G-Secs and 89 bps for 10-year G-Secs.

In September 2019, the RBI had made it mandatory for banks to link their lending rates to external benchmarks like the repo rate. Many banks have since launched new loan products linking their interest rates to the repo rate. In this backdrop, Das now expects faster transmission of rates going ahead.

Even as it left interest rates on hold, RBI slashed its GDP growth forecast to 5.0 per cent for the year ending March 31, 2020, compared with 6.1 per cent it had projected in the previous MPC meet in October. The retail inflation projection, meanwhile, was revised upwards to 5.1 per cent to 4.7 per cent for the second half of the year and 4.0 per cent to 3.8 per cent for the first half of 2020-2021.

“We feel that we need some more time to have greater clarity and less uncertainty about our projections. We just want to be convinced that whatever projections we have made at this point of time, with regards to inflation and growth, the coming months will play out in the same line,” said Das.

All members of the MPC voted in favour of keeping the rates on hold and it maintained that there was monetary policy space for future action.

There had been near unanimity among analysts that the MPC would cut rates by at least 25 bps this time due to the slowing economic growth, but the recent rise in inflation clearly seems to have weighed on the MPC’s decision.

“The outcome of the MPC meet of the RBI indicates that the RBI is worried about rising inflation, which may not come down till at least February 2020, and GDP may not rise materially till the fourth quarter of FY20 as domestic and external demand conditions have remained weak. Hence, it thought prudent not to cut rates at this juncture,” said Dhiraj Relli, MD and CEO of HDFC Securities.

Driven by higher food prices, CPI (consumer price index) inflation in October touched a 16-month high of 4.62 per cent, breaching the RBI’s 4 per cent target. The central bank expects the upsurge in vegetable prices to continue in immediate months, although a pick-up in arrivals from the late kharif season, along with government measures to augment supply through imports, should help soften prices by early February 2020.

Incipient price pressures seen in other food items such as milk, pulses and sugar are also likely to be sustained, which will have implications on the inflation trajectory. The tariff hikes by telecom companies will also weigh.

“Clearly, the MPC is playing by the rulebook and has preferred to watch out for evolution of incoming inflation data amid various idiosyncrasies... Besides, the wait-and-watch approach also appears to be premised on their preference to see maximisation of the percolation of already delivered cuts since February,” said Madhavi Arora, lead economist at Edelweiss Securities.

Analysts are divided on the road ahead for interest rates. Some do believe that there is scope for more rate cuts.

“We think that this easing pause is temporary. In a situation when growth slowdown looks more entrenched and underlying core inflation has slumped to sub-3.5 per cent amid widening output gap, the monetary accommodation still has further steam for another 50 bps in this rate cut cycle,” said Arora.

However, other analysts say with inflation targeting once again taking priority, there was unlikely to be any rate cut for now.

“The actions and response from RBI governor seems to suggest there should be no rate cuts in this current financial year,” said Murthy Nagarajan, head, fixed income at Tata Mutual Fund.

Sunil Kumar Sinha, principal economist and director of public finance at India Ratings and Research, said that in the current environment where both business and consumer sentiments were down, a rate cut alone wouldn’t spur consumption or investment demand. So, allowing various measures announced by the government as well as the earlier rate cuts to play out was perhaps the way forward, rather than reducing the headroom available for a policy rate cut.

“By stating to continue with the accommodative stance and there is monetary policy space for future action, RBI has clearly indicated that the rate cut cycle has not ended, but will be contingent upon domestic and global developments,” he said.

All eyes will also now be on what more steps the government announces to lift the economy.