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India Monetary Policy: Status Quo On Interest Rate And Stance

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Calmed by a dramatic turn in crude oil prices and stability in the Indian currency, the Monetary Policy Committee kept the benchmark policy rate unchanged for the second consecutive meeting.

The monetary policy stance also remains unchanged at 'calibrated tightening' even though a sharp cut in inflation projections may suggest a pause in interest rates for the foreseeable future.

Following the review, the repo rate remains unchanged at 6.5 percent. The reverse repo rate has been held at 6.25 percent. 48 of the 52 economists polled by Bloomberg had expected a status quo in rates.

Separately, the RBI announced a 25 basis point cut in the Statutory Liquidity Ratio starting the January 2019 quarter.

Key Takeaways

  • MPC keeps repo rate unchanged at 6.5%
  • MPC keeps stance at 'calibrated tightening'
  • MPC votes 6-0 to keep repo rate on hold
  • MPC voted 5-1 to keep stance at 'calibrated tightening'; Dholakia voted for neutral stance
  • MPC cuts H2 FY19 inflation forecast to 2.7-3.2 percent from 3.9-4.5 percent earlier
  • MPC pegs H1 FY20 inflation at 3.8-4.2 percent
  • MPC retains FY19 GDP growth projection at 7.4 percent
  • RBI approves linking floating rate loans to external benchmark
  • RBI cuts SLR by 25 basis points starting January 2019 quarter

The MPC's decision to keep rates unchanged was unanimous, although committee member Ravindra Dholakia voted for a stance change back to 'neutral'.

" The decision of the MPC is consistent with the stance of calibrated tightening of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth," said the MPC's resolution.

In his comments after the MPC decision was announced RBI Governor Urjit Patel said space may open up for a change in future policy action.

Post the MPC decision the 10 year bond yield spiked and settled at 7.50 percent, a couple of basis points than it was pre-policy. But comments from the RBI in the media briefing thereafter suggested more open market operations may be undertaken and the yield fell to 7.44 percent.

The rupee strengthened marginally after the policy decision was announced. Equity markets weakened further but have since recovered marginally.

What Experts Said

It definitely was dovish, Ananth Narayan, associate professor of finance at SPJIMR, said of Patel’s comments. It was also comforting to hear Viral Acharya’s comments on liquidity, Narayan added while speaking to BloombergQuint.

The dovish policy paves way for a neutral stance in the forthcoming policy, with inflation projections being significantly lowered, said Shubhada Rao, chief economist at Yes Bank. “See a prolonged pause in rates of oil and currency stabilise at current levels,” Rao added in an interview with BloombergQuint.

The MPC has raised rates twice by 25 basis points each so far this financial year. At its October meeting, while keeping rates on hold, the MPC shifted its stance to ‘calibrated tightening’.

Since then, the backdrop has changed considerably. Crude oil prices have fallen nearly 25 percent between the October and December policy reviews. The rupee has gained close to 5 percent over this period. In addition, inflation has surprised to the downside.

For five consecutive months now, retail inflation has been below forecasts with the downside coming from food prices. Core inflation, however, has remained elevated.

Inflation Forecast Cut

In response to these developments, the MPC cut its inflation forecast significantly for the second half of the current year and the first half of next year.

  • For H2 FY19, inflation is pegged at 2.7-3.2 percent compared to 3.9-4.5 percent earlier
  • For H1 FY20, inflation is pegged at 3.8-4.2%

The cut in inflation forecasts suggests that inflation will come close to the mid-point of the MPC's target of 4 (+/-2) percent, leaving little reason for further rate hikes.

Still, the MPC maintained a cautious stance.

" 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 MPC.

Maintains Growth Forecast

Growth indicators meanwhile, have suggested some weakness. At 7.1 percent, GDP growth came in lower than expectations for the second quarter of the current fiscal year. The data suggested a fall in consumption growth, possibly due to rural distress and heightened crude oil prices. While investment has remained strong, high real rates in India could prove to be dampener for growth going ahead.

However, the MPC has maintained a growth forecast of 7.4 percent for the current year.

"The demand outlook as reported by firms polled in the Reserve Bank’s IOS has improved in Q4. Based on an overall assessment, GDP growth for 2018-19 has been projected at 7.4 percent (7.2-7.3 per cent in H2) as in the October policy, and for H1:2019-20 at 7.5 percent, with risks somewhat to the downside."

Change In Loan Pricing

Separately, the RBI has finally announced a change in the loan pricing mechanism for floating rate loans. Starting April 1, 2019, these loans will be linked to an external benchmark. Banks will have the flexibility to decide on the spread that they want to charge but the spread must remain constant over the period of the loans.

The external benchmarks that the banks can choose from include:

Reserve Bank of India policy repo rate, or

Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL), or

Government of India 182 days Treasury Bill yield produced by the FBIL, or

Any other benchmark market interest rate produced by the FBIL.

Change In SLR

The RBI has also cut the Statutory Liquidity Ratio by 25 basis points. This is in order to align SLR with the Liquidity Coverage Ratio. Scheduled commercial banks have to reach the minimum LCR of 100 percent by Jan. 1, 2019.

"In order to align the SLR with the LCR requirement, it is proposed to reduce the SLR by 25 basis points every calendar quarter until the SLR reaches 18 percent of NDTL. The first reduction of 25 basis points will take effect in the quarter commencing January 2019. " - RBI Statement

Watch live coverage of the MPC decision here...

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