The Reserve Bank of India has cut the repo rate by 25-basis points to 6.25%, in its last bi-monthly meeting for 2018-19.
The move signals both the RBI and the Centre getting in line with each other, after the recent tussle (Click here to know more).
What is the significance?
The RBI had raised the policy rates twice last year, but has maintained a 'neutral' stance in the last two bi-monthly meetings when the MPC did not change the rate.
But it did change the stance from ‘neutral’ to ‘calibrated tightening’ in the fourth meeting in early October 2018.
With a new Governor at RBI now, the Monetary Policy Committee’s view on the state of the Indian economy seems to have changed.
It has now switched its policy stance from ‘calibrated tightening’ to ‘neutral’.
What is RBI's rationale?
The MPC had been over-estimating inflation risks and had stuck to a tighter monetary policy.
But the inflation scenario has been favourable in the last few months.
Consumer Price Index-based inflation have continued to slow and is projected to stay well below the medium-term target of 4%
The MPC has particularly taken note of deflating food prices to adopt a liberal stance with the rates.
The overall demand conditions are moderate, in the backdrop of a slowdown in private and public consumption expenditure.
In the MPC’s view, there is an output gap, and the public spending on infrastructure alone cannot support investment activity.
The RBI also sees the actual GDP growth for 2018-19 to be a bit less than the projected 7.4%.
Production and import of capital goods (a key factor for investment demand) and credit flows to industry remain dull.
There is also a slowdown in farm output growth.
So there is a need for strengthening private investment activity and boosting private consumption which a rate cut is expected to facilitate.
How does the future look?
A policy rate cut facilitating an investment boost is expected to complement the recently released ‘expansionary’ interim budget.
The developmental and regulatory policy initiatives announced alongside the policy is timely and progressive.
Notably, there is a proposal to study the offshore Rupee markets and to rationalise the regulations on the interest rate derivatives which would be of special significance to the financial markets.
However, the Interim Budget has shown some slippage from the fiscal roadmap and projected a budget deficit of 3.4% for both the current financial year and the next.
So the risk of government borrowing, crowding out private investment demand, remains, which the RBI has to be cautious of.
