India’s Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has recently decided to maintain the repo rate at 5.15% in their first bi-monthly policy review of 2019. Despite market expectations of a rate cut due to weak economic growth, the decision to hold the repo rate steady was largely influenced by inflationary pressures.
Since February 2019, the RBI has systematically reduced rates by 135 basis points (bps), marking a clear deviation from its previous trend. However, this time, the repo rate remains unchanged. The reason primarily lies in the revised inflation forecast by the RBI for the second half of 2019-20, which was adjusted to 4.7-5.1% from the initial 3.5-3.7% estimate.
About The Monetary Policy Committee and The Repo Rate
The Monetary Policy Committee acts under the Reserve Bank of India Act, 1934. Its fundamental purpose is to uphold price stability while also considering growth objectives. The RBI’s Governor serves ex-officio as the Chairman of the committee. The committee establishes the necessary policy interest rate (repo rate) to attain the inflation target, currently set at 4%.
Repo rate refers to the rate at which the central bank of a country, in this case, the Reserve Bank of India, lends money to commercial banks should there be a shortage of funds. This tool aids in controlling inflation by increasing the repo rate to reduce borrowing from the central bank. Reduction of money supply in the economy helps control inflation. A low repo rate generally means low-cost loans for the masses. Hence, when the RBI reduces its repo rate, it anticipates that banks will decrease their interest charges on loans.
Snapshot of the Current Economic Scenario
In October 2019, headline inflation rose above the medium-term target of 4%. The main components of India’s headline inflation are food and fuel prices. The recent surge was mostly attributed to rise in food prices. Even though fuel group prices have been in deflation for four consecutive months.
Manufacturing experienced a contraction of 1% in the second quarter following a nearly flat first quarter. This contraction is mirrored in the industry’s capacity utilization, which slipped to 68.9% in July-September 2019 from 73.6% in April-June 2019. Industry output, represented by eight core industries forming 40% of the Index of Industrial Production (IIP), contracted for the second month in a row in October 2019.
Existing Measures and The Stance of RBI
It is anticipated that measures initiated by the Government coupled with the monetary easing exercised by the Reserve Bank since February 2019 will gradually seep into the real economy. The focus needs to be on maximizing the impact of reductions in rates.
| Date | WALR of Commercial Banks | Cumulative Policy Rate Cut |
|---|---|---|
| December 2018 | Increased by 5 bps | – |
| October 2019 | – | 135 bps |
Despite a significant policy rate cut, the Weighted Average Lending Rate (WALR) of scheduled commercial banks between December 2018 and October 2019 saw an increase by 5 basis points. This indicates that the reduction in commercial lending rates by banks has not yet reached retail borrowers.
Potential for Economic Recovery and Challenges Ahead
Early indications suggest a potential recovery in investment activity, based on data on corporate finance and projects sanctioned by banks and financial institutions. However, its sustainability is under scrutiny. The present requirement is to tackle the obstacles preventing investments.
The upcoming union budget (2020-21) will provide a clearer understanding of further measures to be implemented by the Government and their potential impact on growth. On this note, the introduction of external benchmarks is expected to bolster monetary transmission.