RBI Monetary Policy: Economists decode central bank's decision to keep rates unchanged

In an unexpected move, the Reserve Bank of India's monetary policy committee (MPC) decided to hold fire and left the repo rate unchanged. A CNBC-TV18 poll among market participants had shown that the majority of them expected a sixth consecutive rate cut. But, in a unanimous decision, the MPC decided to maintain status quo.

But this was not the only surprise; the market was expecting the RBI to pussyfoot on growth. But the central bank went ahead and handed a sharp cut to its forecast bringing it down to 5 percent.

In fact, in February this year, the RBI had projected a growth rate of 7.4 percent for FY2019-2020 and since then it has been lowered after every policy. With a 110 basis point cut till today, the projection stands at 5 percent.

The market was also expecting the RBI to go all out to help lift growth. But in reality, the central bank made it clear that it is worried about inflation and its own integrity.

The RBI governor warned that food inflation is likely to remain high from January to March and the central bank wants to be sure of the trajectory before taking any action.

So what's worrying the market? The MPC is serious about the 4 percent inflation target. The market assumed that MPC will be comfortable with a 2-6 percent range. But that is clearly not the case.

Another worry for the market is the room for further rate cuts. Is there room only for one or two cuts? CNBC-TV18 spoke to managing director of SBI PK Gupta, Group President at UTI MF Amandeep Chopra, Chief India Economist at HSBC Pranjul Bhandari and ED of Axis Bank Rajiv Anand to decode the RBI policy.

Gupta pointed out that most of the loans in the personal segment, the retail loans, particularly the housing loans, are all linked to the repo rate. MSME loans also are linked to the repo rate. So, whatever cuts have happened that is being passed on. "I think from January 1, the rates will go down further for the customers. So, that way the transmission is already happening. The issue is in the MCLR-linked rates. However, if you look at the entire MCLR, this is formula-driven and if the banks have 40-45 percent as CASA deposits where the rate changes don't really happen, the transmission will always happen to the extent of 60-65 percent of the rate cuts unless you are able to cut your deposit rates which are much larger than the policy rate cuts actually," he said.

According to Anand, the MPC has decided to actually look through the weak growth numbers but has focused its attention on inflation and the fisc. "I think the markets know both are issues as we go forward and it has clearly set the benchmark that much higher for the next rate cut. However, we do not believe that this is the terminal. We are not really obsessed with where the terminal rate is going to close because of the fact that it is not clear what is going to happen to growth and whether the supply side will take care of inflation in the months to come. We do believe that there will be rate cuts from here, maybe one, maybe two but clearly the RBI has set the benchmark for that higher," he noted.

Chopra said the country is nearing the end of the rate cut cycle. "I think one more rate cut was a consensus view and if you really look at it from a perspective of the range of expectations, it varied from as low as 15 basis point to as high as 35 basis point and the larger part of the consensus was around 25 basis point. So nobody in the market believed that there would actually be a pause as far as this policy is concerned. Against this backdrop, the markets are recalibrating their expectations and I think if you have seen the way the rates have reacted both in the benchmark tenure as well as in the swap market it does indicate that the markets are now looking at this more or less being a terminal rate. So 5.15 repo looks to be some sort of terminal repo rate now.  I have always been saying that 6.4 is more or less the floor whether 25 basis point rate cut and the best-case scenario is maybe another rate cut down the line possibly in the next meet," he observed.

But Bhandari thinks the RBI's pause in rate reduction is sensible as the macro package has changed and inflation is up. "I am not saying it is going to be a sharp recovery but I don't see growth falling further from here so it is very different from the policy package that we were confronted with in the last meeting. Add to that I think the bigger point is the credibility of the repo rate. The RBI can keep cutting repo rate but if it is not getting transmitted it is of no use. The markets always take signals from the RBI, but the RBI also has to take signals from the market." she says.