Rate cut yes; but RBI unhappy with transmission!

The benchmark repo rate has been cut by 25 basis points from 5.40% to 5.15%, marking the fifth consecutive rate cut by the RBI starting from February 2019.

October 04, 2019 1:42 IST | India Infoline News Service
Reserve Bank of India
The credit policy announced on October 04, had little by way of surprises. The repo rates were cut by 25 bps, which is appreciable considering that repo rates in India are already at a 15-year low. Here are the key highlights of the policy announcement.
  1. The benchmark repo rate has been cut by 25 basis points from 5.40% to 5.15%, marking the fifth consecutive rate cut by the RBI starting from February 2019.
  2. This cut in repo rates automatically reduces the reverse repo rate to 4.90% and the marginal standing facility (MSF) and the bank rate to 5.40%.
  3. The Monetary Policy Committee (MPC) has maintained the stance of the policy at accommodative considering the growth pressures in the economy.
  4. The RBI has also reiterated that the stance will continue to be “Accommodative” till growth pressures remain and inflation is under the 4% level.
  5. RBI has revised its full year GDP estimate for the fiscal year 2019-20 to its lowest estimate hitherto at 6.1%.
  6. All the six members of the MPC voted to maintain the stance at Accommodative and to cut rates. While Dr. Dholakia voted to reduce the rates by 40 bps, the other five members voted to reduce the rate by 25 bps.
Economic context of the rate cut – Growth and inflation
While the repo rate action has been determined by data flows even in the past, this time around, growth indicators have been specifically weak. In fact, the MPC has noted that the negative output gap has widened further between the last policy and the current policy announcement. The policy also expressed confidence that the government moves to cut tax rates to 22% and the tax rate for fresh investments to 15% would help in boosting consumption and investments. However, the rate cut has been structured with a view to fill the gap at the earliest. The GDP growth for the June quarter came in at a multi year low of 5% and the September quarter is being estimated at around 5.3%. The RBI has also downgraded full year GDP growth to 6.1%. That is partially evident from the negative core sector growth of (-0.5%) for the month of August.

Inflation, despite intermittent concerns over food and fuel, has been largely around the median rate of 3.2-3.5%. However, the policy has pointed to rural stress, which is evident from the sharply lower rural inflation. The RBI has observed that there could be some key parameters shaping inflation going ahead. Kharif output is expected to be lower than last year but vegetable inflation has been on a high due to unseasonal rains. However, RBI expects food inflation to remain subdued due to adequate buffer stocks of pulses. Fuel inflation is in check due to weak global crude prices while core inflation has been consistently trending down. These factors have given the RBI confidence to cut rates by 25 bps to boost growth.

But transmission remains disappointing
The one area where the RBI has expressed disappointment is in transmission of rate cuts. The RBI has noted that between February and August 2019, rates were cut by 110 basis points. If you include the October rate cut, it is 135 bps. However, the total rate transmission to the end borrowers has been just 29 bps if you consider the weighted average lending rate. With banks shifting to external benchmarking from October onwards, in the case of retail and SME clients, the MPC has expressed confidence that the rate cut transmission should be a lot more seamless going ahead.

RBI makes some policy changes too
Apart from the rate cut and economic outlook, the RBI has also given important updates at the policy level. Here are some of the highlights.
  1. To expand the market eligibility for Micro Finance Institutions (MFIs), the RBI announced an increase in the income limit and also the loan limit for eligible borrowers.
  2. To provide more depth to forex trading, domestic banks will be allowed to offer forex quotes to NRIs and rupee derivatives with delivery will be permitted in the IFSC.
  3. On the payment systems, the 24-hour NEFT will go live in December 2019 and the RBI will extend collateralized liquidity support on all NEFT days.
  4. An Acceptance Development Fund (ADF) to be created to extend digital and card facilities to smaller towns and villages and to create appropriate shared infrastructure.
  5. Considering the rapid growth of pre-paid money services, RBI will create an internal ombudsman to redress all grievances of customers.
  6. To extend cross border transactions in Indian rupee and reduce currency risk, persons residing outside India will be allowed to open Special Non resident Rupee (SNRR) accounts without the 7 year tenure limit.

The policy has largely been about reviving growth but the next few policies will be more interesting as room for manoeuvre gets limited. We will get the first indication in the next policy announcement on December 05, 2019.

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