From UPSC perspective, the following things are important :
Prelims level : Nothing Much
Mains level : Rate cut signals economy is in crisis and measures are required to boost growth.
As was expected, the monetary policy committee (MPC) of the Reserve Bank of India delivered its third consecutive rate cut of 25 basis points, citing significant weakness in growth impulses.
- The repo rate now stands at 5.75 per cent. Significantly, all six members of the MPC, including Viral Acharya and Chetan Ghate who had earlier voted against monetary easing, opted not only for a loose monetary policy, but also a shift in stance from neutral to accommodative, opening the door for more rate cuts in the future.
- The message is clear: Inflation remains contained, while the slowdown in economic activity is deeper than what was believed.
- On the inflation front, recent data points towards a broad-based pick up in prices of several food items, increasing the prospects of higher retail inflation in the coming months.
- However, the MPC isn’t perturbed, as it expects a larger reversal in prices during autumn and winter.
- Further, with demand weakening, core inflation has moderated, as have households expectations of three months ahead inflation.
- The RBI now expects retail inflation at 3-3.1 per cent in the first half of FY20, rising thereafter to 3.4-3.7 per cent in the second half, well within the 4 (+/-2) per cent band.
Reasons to worry
- In the economy though, there is reason to worry.
- In February, the RBI had projected the economy to grow at 7.4 per cent in FY20.
- It then lowered its forecast to 7.2 per cent in the April, and has now cut it to 7 per cent.
- But with the underlying drivers of growth sputtering, private consumption, investment and export growth remain subdued, and with limited fiscal space, achieving even this may be difficult.
Does transmission work?
- Will cuts in the repo rate translate to lower lending rates?
- Will it boost consumption and investment demand?
- In the policy document, the RBI noted that while the transmission of the previous two repo cuts was 21 bps to the lending rate on fresh rupee loans, the lending rate on outstanding loans increased by 4 bps as “past loans continue to be priced at higher rates”.
Optimistic notion –
- Perhaps, with liquidity moving into surplus mode — liquidity in the system turned into an average daily surplus of Rs 66,000 crore after being in deficit in April and most of May — transmission will improve.
- The decision to review the liquidity management framework by constituting an internal working group is a positive signal.
The dovish tone of the policy increases the likelihood of another rate cut in August, presumably once concerns over fiscal slippage are addressed after the budget is presented, and greater clarity emerges on the monsoon. Further rate cuts though will depend on the extent of the growth slowdown and the trajectory of inflation.