Central bank retains neutral policy stance, lowers projections for both GDP growth, inflation

The Reserve Bank of India (RBI) carried out a second successive interest rate cut in the span of two months while maintaining a neutral stance, reflecting the central bank’s concerns about sluggish economic growth in India and abroad.

The central bank cut its benchmark repo rate by 25 basis points (bps) to 6% on Thursday. One basis point is 0.01%.

The central bank’s first bimonthly policy statement for 2019-20 stated unambiguously, “The need is to strengthen domestic growth impulses by spurring private investment, which has remained sluggish.”

Coupled with a 25 bps cut in February, and its decisive action on liquidity infusion into the system recently through a combination of instruments, RBI is clearly looking to use monetary tools to stimulate economic growth. In addition, a benign inflationary environment has helped the central bank edge into an expansionary monetary space.

The monetary policy committee members voted 4-2 in favour of the rate cut and 5-1 in favour of maintaining the neutral stance of monetary policy.

RBI’s concerns about the slowing Indian economy are echoed in its revised macroeconomic projections. The central bank has revised its retail inflation projections downwards from its February estimates: 2.4% for Q4 of 2018-19 (against 2.8% in February) and 2.9-3% for the first six months of 2019-20 (3.2-3.4% earlier).

GDP growth projections have also seen similar downward revisions—7.2% for 2019-20 (against 7.4% estimated in February), and,

 6.8-7.1% in the first half of the current year, against the estimated 7.2-7.4% just two months ago.

The concern remains whether bank lending rates will eventually reflect the 50 bps reduction in policy rates over the past two months. Addressing reporters, RBI governor Shaktikanta Das said: “I had earlier held a meeting with banks and some of them have marginally cut the MCLR (marginal cost of funds-based lending rate), but more needs to be done… We will come up with guidelines that will ensure effective transmission of rates.”

Apart from policy rate cuts, RBI has been increasing systemic liquidity through a combination of tools, including buying government securities from the market through its open market operations and conducting three-year dollar-rupee currency swaps. “We will use all instruments, depending on the requirement and other relevant factors… We are particular that effective transmission of rates takes place. It is a work in progress,” Das said.

As part of the regulatory framework, RBI has also eased its liquidity coverage ratio norms that is expected to release more liquidity and help banks boost their lending activity.

There is now a clear shift in RBI’s actions from inflation combat to growth stimulation. The Indian economy’s slowdown has twin facets: lethargic consumption demand and slothful private investment demand.

The marked slowdown in consumption, the mainstay of economic growth over the past few years, spans both public and private segments. This is also reflected in the sharp downward revision in GDP estimates. Overall investment demand, as reflected by gross fixed capital formation, has shown a slight improvement, largely due to continuing government capital expenditure in roadways and affordable housing. While this should have translated into a corresponding uptick in private investment, data shows a shrinking of the key indicators of investment demand: production of capital goods in January and import of capital goods in February.

And while the central bank’s projections show a downward trend in consumer inflation, accompanied by slowing economic growth, these could easily be upset by the vagaries of the monsoon. RBI’s policy document does acknowledge the likelihood of an El Nino affecting crop output or a hardening of vegetable prices during the summer months. In addition, global oil prices continue to be the joker in the pack, with trade tensions or demand conditions determining its future trajectory.

RBI remained rather non-committal about two other factors that could affect the path of consumer inflation in the near future: a preelection expansionary fiscal balance sheet and the impact of RBI’s own liquidity operations on money supply and prices. When asked, Das responded laconically: “The fiscal situation requires careful monitoring.”