The Reserve Bank of India has cut the repo rate by 25 basis points while maintaining a neutral stance, in line with our expectations. Some market participants had expected the RBI to change the neutral stance to accommodative in the current policy, or deliver a 50 basis points rate cut in one go, but the central bank did the right thing, in our view, by not being overly dovish.
Given the near-term undershoot in CPI inflation, the RBI reduced its inflation forecast once again. FY20 growth forecast was also revised down to 7.2 per cent from 7.4 per cent. Despite this downward revision, the forward guidance was more balanced, in our view, with the central bank acknowledging uncertainties regarding the inflation outlook and fiscal position of general government warranting careful monitoring. Possibility of El Niño effects in 2019 was highlighted as a risk to the inflation outlook, as also risks of upward pressure to global oil prices, with OPEC continuing with production cuts. However, the central bank felt that these upward risks will probably be mitigated by slowing global demand and moderating domestic core inflation, as growth momentum slows in the first half of 2019.
The Monetary Policy Committee noted that the output gap remains negative and, in this backdrop, it is justified for monetary policy to play an active role in boosting private investment, which continues to be sluggish. The RBI feels that the cumulative impact of the various measures that have been taken in the past few months (open market operations, FX swap auctions, rate cuts, etc.) will help in aiding transmission, but the central bank did not give any clear indication whether it wants to push the system liquidity in surplus mode (versus the current stance of targeting neutral liquidity) to improve the efficacy of monetary transmission.
The RBI, however, stated that it is open to use all kinds of instruments (OMOs, FX swap auction, etc.) to ensure adequate flow of liquidity, depending on the requirement. By June, system liquidity should turn neutral and this will reduce the need of the RBI’s active support to inject domestic liquidity in the system, assuming the RBI sticks to its stance of targeting neutral liquidity. Consequently, we see monetary transmission improving in the present quarter, though the lending rate cuts are likely to be less than half of the cumulative 50 basis points repo rate cut delivered so far.
As far as future rate cuts are concerned, we expect one more 25 basis points rate cut in this cycle. The RBI has given two back-to-back rate cuts in February and April and it is unlikely it would deliver a third straight rate cut in June, especially with the new Budget for FY20 likely to be announced in July, after the general elections. A more plausible scenario is that the RBI takes a step back, assess the new Budget, and waits for monetary transmission to take place before delivering a fresh round of cut. We are in the camp that believes that the next 25 basis points rate cut would be delivered in August.
Views expressed are personal