Projecting a contraction in growth for the current fiscal, the Reserve Bank of India (RBI) on Friday went for a further 40 basis points cut in policy repo rate, even as it warned that inflation, particularly in food, is on the rise again.
The six-member monetary policy committee (MPC) also kept the policy stance unchanged at ‘accommodative’ for “as long as necessary” to revive growth.
“It is in the growth outlook that the MPC judged the risks to be gravest,” RBI governor Shaktikanta Das said in an online streamed address on Friday morning.
According to Das, inflation will fall below target by the third quarter, even as there has been some spurt now due to supply pressures. Once the central bank gets a better handle on the inflation situation, more room for rate cuts would open up.
The MPC voted with a 5-1 majority to reduce the policy rate by 40 basis points from 4.4 per cent to 4.0 per cent. External member Chetan Ghate voted for a 25 basis points cut. Since March 27, in between the nationwide lockdown, the central bank has reduced its policy rate by 115 basis points in three out of turn MPC meetings, each lasting for three days.
This is the lowest repo rate on record, and such rapid downward revisions were last seen during 2008-09 when RBI governor Duvvuri Subbarao brought down the repo rate from 9 per cent in September 2008 to 4.75 per cent in April 2009.
The RBI is certainly not alone in such rate actions though. Most central banks are not very concerned about inflation in particular at this stage. Economists also largely don’t disagree with RBI’s assessment that prices will soften in the coming months as demand will remain subdued and food prices will get addressed on the face of bumper Rabi harvest, 44 per cent increase in Kharif sowing and a normal Southwest monsoon.
“Of much greater concern would have been the certain growth slowdown and loss of incomes, driven both by demand compression and supply shocks, necessitating a further repo rate cut in an emergency meeting,” said Saugata Bhattacharya, chief economist at Axis Bank.
“This is line with the thinking of all central banks globally, who are unveiling unprecedented post-Covid stimulus responses to fight off fears of deflation, and in some cases, recessions,” Bhattacharya said.
With the reduction of repo rate on Friday, the reverse repo rate, which is he rate RBI gives banks to absorb excess liquidity, also stands reduced to 3.35 per cent from 3.75 per cent.
After the unannounced monetary policy, HDFC Bank reduced its base rate by 55 basis points to 8.10 per cent. State Bank of India (SBI) chairman Rajnish Kumar said both deposit and lending rates will fall further after the RBI’s policy action. Rupee fell 0.44 per cent to 75.96 a dollar, from its previous close of 75.62, Sensex fell 260.31 points, or 0.84 per cent to close at 30,672.59 points as the RBI predicted a contraction in economic growth for 2020-21. Yields on the most-traded bond maturing in 2029, fell 7 bps to 5.965 per cent from its previous close of 6.033 per cent.
Apart from the rate actions, the central bank extended its earlier mortatorium measures by three months. With this, stressed individuals and corporates can forego servicing their loans till August without fearing a deterioration in their credit profile.
The central bank also said interest payments on working capital can be spread till March 2021, instead of up to September allowed earlier. To enable banks give more credit to the corporate sector, the RBI increased the group exposure limits of banks to 30 per cent from 25 per cent earlier.
Governor Das noted that the MPC had not initially anticipated the impact of the pandemic to be as severe. And so, judging that the risks to growth are acute, while the risks to inflation are likely to be short-lived, the MPC felt it was essential now to “instil confidence and ease financial conditions further,” in order to “facilitate the flow of funds at affordable rates and rekindle investment impulses,” Das said.
But analysts have started questioning if the growth slowdown can be addressed by RBI rate cuts alone.
“While the policy easing is welcome, the effectiveness of rate cuts and excess liquidity on delivering the growth bang is incrementally diminishing in a scenario of rising credit risk aversion among lenders. Hence, while we expect the RBI to deliver more easing, the real policy punch needs to come from unconventional monetary policy to navigate around the balance sheet issues,” said Sonal Varma, chief economist of Nomura India and Asia (ex-Japan).
The RBI governor rather painted a grim picture of the economy in his morning address. The two months of lockdown has severely impacted the industrial proiduction as the top six industrialised states that account for about 60 per cent of industrial output are largely in red or orange zones.
The combined impact of demand compression and supply disruption will depress economic activity in the first half of the year, Das said, adding that even if economic activity gets restored in a phased manner in the second half, the recovery will only be gradual.
The growth numbers can take comfort in base effect, as well as the combination of fiscal, monetary and administrative measures being currently undertaken. Downside risks continues to be significant and contingent upon the containment of the pandemic and quick phasing out of social distancing and lockdowns.
“Given all these uncertainties, GDP growth in 2020-21 is estimated to remain in negative territory,” Das said.
Das stayed away from providing specific projections on growth awaiting release of national statistical office (NSO) estimates on national income in end-May.
Das noted that Investment demand has been virtually halted.
“The biggest blow from COVID-19 has been to private consumption, which accounts for about 60 per cent of domestic demand,” Das said. However, agriculture and allied activities have “provided a beacon of hope” on the back of an increase of 3.7 per cent in foodgrains production to a new record.
The good agriculture outlook “will support farm incomes, improve the terms of trade facing the farm sector and strengthen food security for the country. Going forward, these would also have a salutary effect on food price pressures,” the governor said.
The RBI, though, stayed away from providing a comprehensive assessment on inflation as there is only partial data available. Therefore, the MPC’s guidance on inflation remained directional, rather than level specific.
The MPC expects the inflation to remain firm in the first half of 2020-21, but should ease in the second half, aided also by favourable base effects. By the third quarter, inflation could also fall below the target (RBI targets to keep inflation at the mid-point of 4 per cent).
India’s foreign exchange reserves, at $487 billion, however, is enough for a year’s import.