RBI cuts repo rate by 25 basis points, changes policy stance to neutral.

The monetary policy committee of the Reserve Bank of India today cut the policy interest rate by 25 basis points to 6.25% in a 4-2 decision. The move could spur banks and non-banking finance companies into reducing their lending rates for consumer and home loans, resulting in lower EMIs for borrowers. In another key move, the central bank changed its stance to ‘neutral’ from the earlier ‘calibrated tightening’.

The RBI policy is a very dovish one and signals further rate cuts. Inflation estimates have been revised very sharply lower by the central bank. The panel cut its estimates for inflation based on consumer prices for the first six months of the next financial year (April-March) to 3.2%-3.4% from 3.8-4.2% earlier, a cut in estimates by as much as 60 basis points. The central bank also lowered its inflation projection for the entire year 2018-19 to 3.9%.

The committee has been more influenced by the persistently low inflation based on retail consumer prices. The MPC is mandated to target headline inflation based on the consumer price index (retail inflation). As per its target for the current period, that is set at 4%. From 4.92% in June, CPI inflation fell to an 18-month low of 2.19% in December, staying below the medium-term target of 4% for five consecutive months.

In cutting the rate, the committee has chosen to ignore high core inflation as well as the government’s unimpressive performance on the fiscal front. According to Union Budget 2019-20 — an expansionary one — the government has slipped on its fiscal deficit target for the second year in a row and the next fiscal year, too, won’t see any consolidation. The 2018-19 number slipped by 10 basis points to 3.4% after revision and is projected to stay the same in the next 12-month period starting April.

Hopefully, the RBI’s move should also help ease the liquidity situation in the market, currently facing the IL&FS imbroglio, debt defaults by other corporates and high NPAs in the banking sector. A banker told Mint that the cost of borrowing for even ‘triple-A’ rated companies had risen to 10.5%-11.0% with home loans being given out at 9% plus and car loans at 10.5%-11.0% to retail consumers. The rate cut should help banks and other lenders bring down those rates.

The central bank also projected an economic growth rate of 7.4% for the next fiscal year, up from 7.2% estimated for the current fiscal year by the Central Statistics Office (CSO). GDP growth is likely to be influenced by growth in bank credit and overall financial flows to commercial sectors, though slowing global demand could play a dampener, according to the RBI document released after the MPC.

In its December policy, the RBI had projected a GDP growth rate of 7.4% for 2018-19 (7.2-7.3% in the second half and 7.5% for the first half of 2019-20) with risks somewhat to the downside.

The CSO has estimated GDP growth at 7.2% for 2018-19. (Source:Livemint)