Monetary Policy - MPC sticks to 'No Rate Cuts'

The stance of the Monetary Policy Committee was evident in the December policy itself. It did not intend implementing anymore rate cuts in the midst of rising inflation. In the two inflation announcements post the December policy, inflation scaled up by over 270 bps touching a multi-year high of 7.35% in December 2019. With food prices continuing to remain high, the inflation is expected to be above 6% in Jan-20 too.
Figure 1- Rising inflation is the crux of the problem        
Data Source: MOSPI

There is another subtle shift that has happened in the last few months. The Union Budget announced on Feb 01, 2020 clearly laid out a new tax regime that was focused on tweaking the tax structures for the entry level taxpayers. The idea was to use tax cuts to boost consumption and, consequently, growth. It also signifies an underlying shift, where the government is relying less on monetary policy and more on fiscal policy to drive growth. It is in this background that the February 2020 monetary policy was announced.
Highlights of the Monetary Policy

There was not much of a surprise element in the monetary policy announcement with the December policy laying out the broad contours of the monetary stance.
  • The repo rate has been maintained at 5.15% and this status quo was largely along expected lines.
  • As a result, the reverse repo rate stays at 4.90% and the bank rate and marginal standing facility (MSF) stays put at 5.40%.
  • The MPC has retained its monetary stance at “Accommodative” hinting that rates will be low till growth picks up.
  • The 6 members of the Monetary Policy Committee voted unanimously for maintaining status quo on the repo rates and also on the monetary stance.
How the MPC justified its rate status quo?

MPC had already hinted in the December policy minutes that rate cuts were ruled out if inflation remained high. Here is what we can gather from the policy statement.
  • While inflation remained high at 7.35% for December and is expected to remain elevated in January too, the MPC expects that the sharp fall in the price of Brent crude (from $70/bbl to $54/bbl) and tempering of food prices should lower inflation.
  • With GDP estimates for the full year ranging between 5.5% and 6%, the MPC underlined the need to keep the stance accommodative. However, the MPC also pointed out that the high frequency indicators like IIP and core sector had shown a turnaround in November after 3 months of negative growth. In addition, the PMI manufacturing and the PMI services for January are at a 7-year high, giving the MPC confidence to hold rates and wait for the growth impulses to kick in.
  • MPC also noted that on the supply side, the Rabi sowing was 9.5% higher and with near 70% reservoir storage the stage was set for tempering of food prices. Production of the most vulnerable vegetables like onions, potatoes and tomatoes were up by 2.6% for fiscal 2020 as per early estimates.
  • The MPC also observed that the external benchmarking of loans since October 2019 was beginning to work and the transmission had begun to improve. For example, the transmission in the case of G-Sec yields was almost 100% at the shorter end and close to 60% at the longer end. The marginal WALR (weighted average lending rate) on rupee loans had fallen by almost 70 bps and hence the MPC considered it worthwhile to wait for some more time for the full impact of transmission to kick in.
But, the monetary policy covered a lot more than rates
In the last few policy announcements, a lot of critical issues other than the repo rates have been dealt by the RBI. Here are some of the additional measures announced by the RBI as an adjunct to the policy announcement.
  • Under the long term repo operations (LTRO) facility effective Feb 15, 2020, RBI will conduct repos of 1 year and 3 year tenors up to Rs1 trillion to keep a balance in the system and assure the money and bond market participants of durable liquidity.
  • The RBI will be focusing on credit flow to sectors with multiplier effect. Thus banks will be allowed to deduct incremental credit to automobiles, residential houses and MSMEs from their NDTL for maintenance of CRR. This could be a big boost for directed credit.
  • RBI also announced that all fresh loans to MSMEs shall be mandatorily externally benchmarked. The policy statement also announced a one-time restructuring scheme specifically aimed at reducing the burden on MSMEs.
  • To simplify and streamline the payment system in India, the RBI announced the periodic publication of a Digital Payments Index (DPI) to capture digitization of payments. RBI also mooted the idea of a SRO to help digital payment to growth in a more organized way. The pan-India cheque truncation system (CTS), which was launched in 2010, is proposed to be extended pan-India by September 2020.
The policy was largely along expected lines with the MPC maintaining status quo on rates and on the stance. Of course, we will have to await the full text of the minutes on 20th February. The next policy in April 2020 may pose bigger choices for the RBI!

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