RBI holds rates, cuts inflation forecast

POLICY GUIDANCE RBI’s MPC decides to retain calibrated tightening stance

MUMBAI: The Reserve Bank of India (RBI) kept its policy rates unchanged on Wednesday, as was widely expected, and cut its inflation forecast for the rest of the financial year, citing a sharp fall in crude oil prices and food “deflation”.

The central bank also introduced proposals to improve policy rate transmission and credit discipline, besides initiating a predictable liquidity injection over the next six quarters, starting January, through a phased reduction of 25 basis points (bps) every quarter in statutory liquidity ratio (SLR). The six-member Monetary Policy Committee (MPC) voted unanimously to keep the policy rate unchanged at 6.5%. Barring Ravindra Dholakia, the MPC voted in favour of maintaining the earlier stance of “calibrated tightening”. Dholakia, who is known for his dovish stance, voted to change the stance to neutral.

The MPC slashed its inflation projection to 2.7-3.2% from 3.9-4.5% for the second half of the current financial year. It expects inflation to quicken to 3.8-4.2% in the first half of the following year.

“Given the assessment that growth will remain healthy for the rest of the year, the MPC retained its stance at calibrated tightening so as to buy time to pause, reflect and undertake future policy action with more robust inflation signals. If upside risks do not materialize or are muted in their impact as reflected in incoming data, there is a possibility of space opening up for commensurate policy actions by the MPC,” RBI governor Urijit Patel said.

The bond markets, which interpreted this as a possibility of a future rate cut, saw the 10-year bond yield fall over 13 basis points during trade. The 10-year government bond yield closed at 7.441%, a level last seen on April 13, from its previous close of 7.573%.

While the MPC reduced the inflation forecast, it retained the gross domestic product estimate for FY19 at 7.4% with “risks somewhat to the downside”, possibly to account for the credit squeeze and demand weakness.

RBI’s new liquidity management framework incorporates an SLR reduction by 25 bps every quarter until the SLR reaches 18% of net demand and time liabilities (NDTL). While this reduction is unlikely to have a material impact on domestic liquidity, it is part of the roadmap to align SLR with 100% Liquidity Coverage Ratio (LCR). LCR is the amount of high-quality liquid assets that banks have to set aside to meet short-term obligation.

“The RBI decision to keep rates on hold was more in consonance with market expectations but the policy guidance was a pleasant and pragmatic surprise. The significant downward revision in inflation projections and assurance of continued durable liquidity was most reassuring to market participants in terms of a stable and predictable interest rate structure,” said Rajnish Kumar, chairman, State Bank of India. Governor Patel also ruled out any possibility of a cut in cash reserve ratio (CRR) to enhance liquidity.