In a much-anticipated move, the Reserve Bank of India (RBI) cut rates by 25 basis points (bps) in its April policy review, reducing the benchmark repo rate to 6 percent, while maintaining a neutral policy stance. This marks the second consecutive rate cut after the February policy review.
While the market did anticipate the move unlike the last policy action, however, what caught the eye was a much more bearish outlook by the central bank for FY20. We did anticipate the central bank to revise FY20 GDP growth forecast of 7.4 percent, which it revised downwards to 7.2 percent. However, it also revised lower the CPI inflation forecast for FY20 to 3.3 percent, assuming normal monsoon, along with revising the FY19 forecast, now at 3.4 percent.
Though the inflation forecast for FY20 is much lower from the February policy heads-up, however, the caveat here lies in the strengthening of the El Nino conditions. The central bank has not yet accounted for the El Nino impact on the inflation forecasts, though it did acknowledge the likelihood of it impacting the normal south-west monsoon. In case the El Nino condition strengthens further, we expect the food prices to rise by more along with unfavourable base and summer seasonality kicking in. Taking this into account along with the risks of a rise in global crude oil prices, which have risen by 27 percent year to date, and possible fiscal slippage, risks might emanate to the central bank’s inflation forecast. For now, the declining core inflation momentum and lower food prices provide comfort to the central bank’s view.
On the growth front, weakening rural and urban demand, negative output gap, moderation in industrial production and core industries index, and lowering of capital goods imports suggests increasing growth headwinds. This clubbed with external demand uncertainty amidst lingering trade tensions and geopolitical concerns make a good case for monetary policy easing. Globally, major central banks have already adopted a dovish outlook which further necessitated such a move.
Amidst a low inflation-low growth environment, a 25 bps rate cut looked warranted. Any further moderation in growth or inflation would be suggestive of another rate cut in either Jun-19 or Aug-19 policy review.
Together with monetary easing, RBI’s increased focus on liquidity transmission is a welcome move. In this regard, the central bank’s move to reckon an additional 2 percent of g-secs within the mandatory SLR requirement as FALLCR (Facility to Avail Liquidity for Liquidity Coverage Ratio) for the purpose of computing LCR (in a phased manner) will not only enable effective management of liquidity by bank balance sheets, but it would also raise potential lending capability of banks, thereby supporting the flow of funds to the economy.
(Shubhada Rao is chief economist at Yes Bank)