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HomeEconomyMessage from RBI: Expect more rate cuts this year

Message from RBI: Expect more rate cuts this year

RBI changing its monetary policy stance to accommodative indicates it will bear a greater burden of expansionary macro-economic policies.

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The Reserve Bank of India’s Monetary Policy Committee unanimously voted to cut the policy interest rate by 25 basis points. This is a welcome move as signs of a slowdown in the economy are stronger than before. This is the third rate cut in a row since Shaktikanta Das became RBI governor in December 2018.

RBI also changed its monetary policy stance to accommodative, indicating that policy rates may be cut again and liquidity could be increased in the coming months.

The RBI decision was expected by the markets after the data on GDP growth and jobs indicated demand was cooling. In addition, the data on tax revenue collections also point to limited fiscal space. This means that monetary policy will bear a greater burden of expansionary macro-economic policies in the coming months.

Core inflation

Inflationary expectations are muted even though food inflation is a bit higher than in previous months. The decision to cut rates even though food inflation is higher should put to rest fears about the framework that when food inflation is high, a central bank targeting inflation would necessarily be raising policy interest rates.

The factors that play into setting rates are output and demand conditions and the core inflation rate.


Also readInterest rate cuts will make a difference only when they’re transmitted down the line


Demand slowdown

The major factor that played a role in the rate-cut in this MPC meeting appears to be a slowdown in demand. Both global and domestic demand are showing signs of a slowdown. The section on growth in the MPC statement are peppered with the words “muted”, “moderated” and “anaemic” in descriptions of various production series.

Importantly, while there had been signs of export and investment slowdown for many years now, the signs of a slowdown in consumption demand, especially rural demand, as the RBI notes, are relatively new. There seems to be a fear of a broad-based slowdown in demand.

Transmission

RBI has set up a committee to examine the framework for liquidity management. Better liquidity management, along with better communication is critical for improving the transmission of monetary policy or of the rate cuts to lending rates across the economy. With the crisis in the NBFC sector building up further with a near-default by DHFL, difficulties with the liquidity situation are likely to continue unless seriously addressed.

Unless the 75 basis-points rate cut in the last 3 policies leads to lower interest rates for borrowers, demand is unlikely to pick up and the economy will not see gains from easing of monetary policy.

Looking forward

With the change in stance to accommodative, a lower growth forecast (to 7 per cent in fiscal 2020 from 7.2 per cent) and RBI maintaining its inflation forecast at 4 per cent, it is likely that the central bank will cut rates again later this year. The impact, however, will strongly depend on the transmission mechanism.


Also readRBI is becoming the model central bank to the world


 

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1 COMMENT

  1. As part of a much larger initiative to restore the economy to health, rate cuts might do some good. However, if no meaningful reforms are contemplated, the RBI dutifully cutting rates – amidst a drought of liquidity – is as effective as pushing a string.

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