RBI Cuts Interest Rates by a Quarter Point

Mumbai: Reserve Bank of India (RBI) Governor Urjit Patel cut interest rates by a quarter point as forecast by economists citing softening inflation outlook and retained growth forecast but said outlook is improving with good monsoon. All six of the monetary policy committee unanimously voted in favour of the rate cut.

“The Committee expects that the strong improvement in sowing, along with supply management measures, will improve the food inflation outlook,” RBI said. “The sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect.”

The RBI lowered its repo rate by 25 basis to 6.25% and maintained that it would continue with its accommodative monetary stance. This is the first instance where a monetary policy committee of 6 members is deciding on the interest rates.

“The accommodative stance of monetary policy and comfortable liquidity conditions should support a revival of credit to the productive sectors,” RBI said.

The Reserve Bank of India also said that the growth momentum in the economy would continue. “The momentum of growth is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award,” it said.

Taking into account these shocks to the baseline and given the initial conditions in staff projects inflation to ease modestly through 2017-18 and reach 4.5 per cent by Q4 of 2017-18 and reach 4.5 per cent by Q4 of 2017-18 (2.1 per cent to 7.7 per cent defining the 70 per cent confidence interval).

Mr. Sunil Sinha, Principal Economist of India Ratings & Research (Ind-Ra) says, “As against Ind-Ra’s expectation of no rate cut, RBI cut the repo rate by 25bp in the 4th bimonthly monetary policy statement of 2016-17. Although newly constituted Monetary Policy Committee still views risk to be tilted towards upside with respect to headline CPI inflation reaching 5% by March 2017, it chose to cut the policy rate. That the risk is tilted towards upside, is also captured by the RBI’s inflationary expectation survey of September 2016 whereby households have raised their inflationary expectation. Further, input costs in the manufacturing sector, including staff costs, have firmed up, although corporate pricing power is still somewhat stunted due to slackness in the demand. Ind-Ra believes this is clearly a case of front loading the rate cut and resting the hope on moderation of food inflation due to favourable monsoon and its impact on crop production particularly pulses, without giving adequate weightage to the lethal combination of structural/cyclical component of food inflation which has more than often surprised on the upside rather than on the downside in the recent past.”