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RBI’s shift to ‘neutral’ stance and rate cut geared to complement fiscal reflation to enhance consumption


In its sixth bi-monthly monetary policy meeting held on February 7, the Reserve Bank of India (RBI) announced a change in its policy stance to ‘neutral’ from ‘calibrated tightening’.

What took the market and everyone by surprise was the monetary policy committee’s (MPC) decision to lower the repo rate by 25 basis points to 6.25per cent from 6.5 per cent. Although we would say that the decision to tweak the stance was broadly in line with consensus expectations, the rate cut was somewhat unexpected.

The meeting also marked the first monetary policy review under Shaktikanta Das, who has taken over as the RBI Governor in December after the sudden exit of Urjit Patel.

The rate cut decision has been justified on the basis of a sharp reduction in projected headline inflation by the central bank. We believe that the combination of reflationary budget presented on February 1, by Interim Finance Minister Piyush Goyal along with the latest monetary easing announced by the RBI will provide a further boost to consumption demand in the election-bound country.

CPI inflation has been revised downward to 2.8 per cent for Q4FY19, 3.2-3.9 per cent for Q3FY20, and 3.4 per cent for H1FY20. Headline inflation is projected to remain soft in the near term, reflecting the current low levels of inflation and the benign food inflation outlook.

In our view, the implications on inflation is somewhat on the higher side and the RBI may have taken a benign view in this respect. Core inflation remains high, averaging at 6 per cent over the past six months. This is significantly higher than non-core components, which was -1.4 per cent in December 2018. Hence, with the monetary policy decision significantly aligned with the headline inflation, the decision reflects a larger influence of the non-core inflation. We believe that the combination of fiscal expansion and rate cuts will induce an upside risk to core inflation over the medium term.

The central bank has also enhanced the limit for collateral-free agri loans to Rs 1,60,000 from the earlier Rs 1,00,000. This measure is aligned with the big fiscal boost provided to the sector in the recent union budget. One can expect a stronger push on banks to accommodate larger agri-loan waivers and an enlargement in credit risk on the agri-loan portfolio, with the country heading toward crucial general elections this year amid widely perceived farm distress.

The bank has also eased the ECB norms for corporates, using which they can borrow up to $750 million through the automatic route without the restriction of end-use to repay existing rupee loans. This is being done to relax the funding pressure arising from the tightening credit conditions in the domestic market. This becomes relevant especially in the context of funding constraints faced by NBFCs and companies undergoing insolvency and bankruptcy process. The move can provide a short-term respite to the BFSI sector as well as to stressed corporate houses.

However, we are of the view that the move will also expose Indian corporates to currency risks, going forward, while it also fails in addressing the core credit risk issue.

Source: Economic Times