Reserve Bank of Indian keeps key interest rate on hold, cuts FY20 GDP forecast sharply

The Reserve Bank of India kept the policy repo rate on hold today, an unexpected unanimous decision after five straight rate cuts in 2019. The decision was based on the recent rise in inflation as well as the prospects that it will stay elevated in the near term.

RBI Governor Shaktikanta Das stated that the Monetary Policy Committee will wait for better clarity on the inflation and growth trajectory and therefore found it worthwhile to pause. This will also permit them more time to assess the effect of counter-cyclical measures, including fiscal ones, taken so far.

Meanwhile, the central bank cut its GDP growth projection sharply for FY20 (fiscal year ending March 2020) to 5 percent from 6.1 percent in the previous policy meeting. They noted that economic activity has softened further and the output gap continues to be negative.

The RBI also adjusted its inflation forecast higher to 4.7 percent to 5.1 percent in the second half of FY20 from 3.6 percent previously. Nevertheless, it expects inflation to ease to 3.8 percent to 4 percent in the first half of FY21. It noted that vegetable prices will stay high in the immediate months and that household inflation expectations have hardened lately.

“On our part, we acknowledge the recent rise in inflation and its persistence in the near term. At the same time, we firmly believe that it is transitory, caused by higher prices of select food items, most notably those of onions. We do not think that this problem can be resolved by monetary policy but rather by supply-side measures”, noted ANZ in a research report.

The MPC, for the first time in recent statements, acknowledged that monetary transmission has been “fully and reasonably swift” throughout money and private corporate bond markets. It noted that the transmission of the cumulative 135 basis points of cuts made between February and October 2019 to the ‘weighted average lending rate (WALR)’ on fresh rupee loans was 44 basis points and 49 basis points on the 1-year median marginal cost of lending rate (MCLR).

“Overall, we see today’s move as the RBI’s admission that rate cuts are not a given. Fortunately, the commentary continues to tilt on the dovish side, keeping door open for further cuts. We therefore, retain our expectations of a 25bp cut in February 2020, contingent on inflation remaining within the RBI’s near-term projections”, added ANZ.