RBI keeps repo rate unchanged at 6.50%, seeks to prod banks to lend more

The Reserve Bank of India (RBI) on Wednesday kept policy rates and stance unchanged but cut its inflation expectations sharply, for now, owing to the recent correction in crude oil prices.

RBI Governor Urjit Patel indicated that the policy course could change soon, depending upon the movement in oil prices.

“We need a few more data points to ascertain the durability of the decline in inflation that has taken place in a very short period of time — especially with respect to oil where the implied volatility is higher now than in October, although the price of oil has come down,” Patel said. “With incoming data, our projections will change. We will take a call as and when required,” he added.

In October, India’s retail inflation had eased to 3.31 per cent.

KEY TAKEAWAYS

Retail and micro, small and medium enterprises (MSMEs) loans to be linked to an external benchmark from April 2019  
 

SLR to be cut to 18% with quarterly 25 bps reduction from January 2019
 

Expert committee on MSMEs proposed
 

Non-resident Indians can trade in interest rate derivatives 
 

Mandatory loan component in working capital finance from April 2019
 

Limited liability brought in for users of prepaid payment instruments

Reviewing the fifth bi-monthly monetary policy, all the six monetary policy committee (MPC) members voted in favour of keeping the policy repo rate unchanged at 6.5 per cent. However, external member Ravindra Dholakia voted to change the stance to neutral. The stance continues to remain as ‘calibrated tightening’ as the central bank awaits more data to assess the inflation outlook better.

The RBI revised down its inflation forecast to 2.7-3.2 per cent in the second half of the current fiscal year from 3.9-4.5 per cent earlier. Also, the central bank expects CPI inflation to be at 3.8-4.2 per cent in the first half of 2019-20, as against 3.8 - 4.5 per cent projected in the October policy.

“With this downward revision of inflation projection and acknowledgment of the downside risks to growth, the Monetary Policy Committee (MPC) has guided for a possible change in policy stance back to ‘neutral’ in February 2019 meeting from ‘calibrated tightening’ now,” said Gaurav Kapur, chief economist of IndusInd Bank.

 

“Although recent food inflation prints have surprised on the downside and prices of petroleum products have softened considerably, it is important to monitor their evolution closely and allow heightened short-term uncertainties to be resolved by incoming data,” said the resolution of the MPC.

In his opening remarks, the RBI governor said although prices of several food items were at unusually low levels, “there is a risk of a sudden reversal, especially of volatile perishable items”. “Volatility indicators of crude oil prices and financial markets have not softened, suggesting that there remains considerable uncertainties in oil prices and international financial markets outlook, depending upon other factors such as Opec supply decision later this week and how the trade war, truce, or otherwise, plays out,” Patel added.

“We really need some time in order to assess the inflation outlook better, and then we will be able to take a further policy action, if necessary,” said Deputy Governor Viral Acharya.

The central bank, however, was comfortable about its growth forecast, which they kept unchanged at 7.4 per cent for 2018-19 and 7.5 per cent for the first half of the next fiscal year. However, there were certain downside risks, such as a possible slowdown in rural demand.

“The central bank’s view on growth is more optimistic than the Street and our forecasts,” said Radhika Rao, economist at DBS Bank.  
 

In the July-September quarter, the annual growth rate fell to 7.1 per cent from 8.2 per cent in the previous quarter. However, the RBI noted that apart from the low oil prices aiding growth, capacity utilisation in the manufacturing sector was improving, which would entice more investments. “There has been significant acceleration in investment activity and high frequency indicators suggest that it is likely to be sustained.”

Credit growth at 15.6 per cent is higher than nominal GDP growth, while foreign direct investment (FDI) flows could increase with the improving prospects of the external sector. Investment activity is also showing signs of a pick-up, and would benefit if fiscal discipline is maintained, it said. As part of its long-term plan to make the liquidity coverage ratio (LCR) as the main measure of liquidity in a bank, the central bank said it would progressively bring down the statutory liquidity ratio (SLR) by 25 basis points every quarter, starting next quarter, till the SLR gets reduced to 18 per cent from 19.5 per cent now.

The rupee strengthened marginally to close at 70.47 a dollar from 70.49 a dollar just before the policy announcement, while the 10-year bond yields fell to 7.44 per cent from 7.54 per cent before policy.

“The lowering of inflation projections implies that at least for the next one year, the central bank will be in the pause mode, which is positive for the bond market. The SLR reduction, though it will lead to demand destruction, will infuse ~1.5 trillion of liquidity over a period of time, which is bond positive,” said Ramkamal Samanta, vice-president, investments, Star Union Dai-Ichi Life Insurance.

Acharya also suggested that the central bank would be there for the NBFC sector as the lender of the last resort, but its preference was to take measures for the system as a whole.

In the policy press conference, Acharya assured the market of adequate liquidity through secondary market bond purchases, or through long-term lending at near overnight rates (repo lending) at times of liquidity stress. SBI Chairman Rajnish Kumar said, “The significant downward revision in inflation projections and assurance of continued durable liquidity were most reassuring to market participants in terms of a stable and predictable interest rate structure.” The central bank also permitted non-residents to hedge their rupee interest risk, and allowed them to participate in the overnight-indexed-swap market for non-hedging purpose.