The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), in its fifth bi-monthly monetary policy review for fiscal 2020 today, gave pause to cutting repo rate. The unexpected break came after five consecutive cuts this calendar year and as opposed to the wider expectation of a 25 basis points (bps) cut this time around, too. Hence, the repo rate continues to stand at 5.15%, and the reverse repo and marginal standing facility rates, at 4.90% and 5.40%, respectively. The decision to hold the policy rate was unanimous. The MPC also decided to continue with the accommodative stance, as long as it felt it necessary to revive growth.
The decision not to cut the policy rate was guided by the current rise in inflationary pressures and gradual improvement in monetary transmission. Importantly, the RBI is looking for more clarity on data, particularly the fiscal stance in upcoming Union Budget, before taking further action.
Focus reverts to inflation: Sharp rise in the consumer price index (CPI) based headline inflation in the past two months has led the MPC to hold further rate cut at this juncture. Surge in vegetable inflation led headline inflation to rise to 4.6% on-year in October. The RBI expects food inflation, particularly vegetables, to remain elevated in the immediate months. It also sees pressure from other food items such as pulses, milk, etc. A likely rise in telecom prices could also push up core inflation. The MPC, accordingly, revised upward its inflation projection to 5.1-4.7% second half of current fiscal from 3.7-3.5% projected earlier. Another worry is that, given the adaptive nature of households, the current spike in food inflation has led their inflation expectations to go up. As per the MPC resolution, “Households’ inflation expectations, measured by the Reserve Bank’s November 2019 round of the survey, increased by 120 basis points over the 3-month ahead horizon and 180 basis points over the 1-year ahead horizon”.
Ample scope for monetary transmission: The MPC acknowledged that monetary transmission, which has been swift across money market instruments, is now also improving for credit markets. According to the MPC, the 1-year median marginal cost of funds-based lending rate (MCLR) has declined 49 bps in response to the 135 bps cut in policy rates so far. “After the introduction of the external benchmark system, most banks have linked their lending rates to the policy repo rate of the Reserve Bank. The median term deposit rate has declined by 47 bps during February-November 2019. The weighted average term deposit rate declined by 9 bps in October as against a decline of just 7 bps in eight months during February-September. This augurs well for transmission to lending rates, going forward”, it noted. Despite improving transmission, the slowing credit growth is worrisome. If a slowing economy has reduced credit appetite, risk aversion and weak sentiment has diminished the willingness to supply credit, too.