RBI Cuts Repo Rate by 25 bps, Changes Stance to Accommodative

A dazzling combo – 25 bps repo rate cut plus accommodative stance

There were big expectations built around the monetary policy of June for various reasons. A new government had taken office and the new finance minister had promised to unleash the capitalist sinews of free markets. At the same time, the GDP growth rate had fallen to 5.8% in the fourth quarter and the full year growth was at 6.8%. To add to this, the NSSO had given a discouraging figure of 6.1% unemployment, something India had not seen in 45 years. Global macros were weakening due to the trade war and geopolitical risk was rising in the Middle East. In the midst of all these macroeconomic fault lines, the NDA government had returned with a thumping majority. Obviously, the expectations were quite high!

What the policy said on the monetary and macros front?

• The repo rate has been reduced by 25 bps from 6% to 5.75%, which was slightly below what the optimists in the market were expecting. While this was a policy response to weak growth, the MPC has also been cautious due to the risks to inflation in case of a weak monsoon pushing up food prices. IMD and SKYMET have been neutral to negative on monsoons.

• The stance of the monetary policy has been changed from Neutral to Accommodative clearly indicating that the RBI kept the doors open for more cuts if justified by data. Interestingly, all the 6 members of the MPC voted unanimously for the 25-bps rate cut and also for the change in the stance of the policy to Accommodative.

• This rate cut reduces the reverse repo rate to 5.50% and the bank rate and the MSF rate to 6%; both with a spread of 25 bps either side of the repo rate. However, the net impact will just be 25 bps cut in last one year because the MPC had hiked rates by 25 bps each in June and August 2018 and later cut by the same amount in February and April 2019.

• The MPC has hinted at comfortable liquidity conditions in the market through a mix of open market operations (OMO) and dollar swap auctions as and when required. The dollar swap auctions were introduced by the RBI in April to simultaneously infuse liquidity into the system and also draw out idle dollars from the banks to prevent rupee appreciation beyond a point.

• The real highlight of the policy is the need to read the rate cut in conjunction with the shift in stance of the policy. RBI has sent a message to banks on rate transmission to the borrowers which had not happened in the first two rate cuts. The banks will now have to move faster if they anticipate more rate cuts from the RBI.

• RBI is also provisioning for a likely weak monsoon as indicated by the IMD and the SKYMET which could have an impact on output and prices. The shift in stance gives the MPC and the RBI more time and elbow room to take further action based on the data flows.

Beyond monetary measures alone…

• This policy has attempted two things. Firstly, it has left a lot of onus on the fiscal policy to be announced as part of the Union Budget on July 05^th. Secondly, the policy has put out a series of announcements beyond the realm of just rates and liquidity. Here are some of the key highlights.

• Liquidity ratio for banks shall be fixed at 4% for systemically important banks and 3.5% for other banks to bring about harmonization with global Basel standards over a period of time.

• RBI wants to go slow on new bank licenses and the proposal to put payment bank licenses on top has been temporarily put on hold till there is a greater performance to show.

• Considering the complexity of current holding structures that are multi-layered through CICs, the MPC has proposed to set up a working committee to review regulatory guidelines and the supervisory framework for Core Investment Companies (CIC).

• Foreign exchange trading will be available on a neutral platform for retail investors and this will be made available from August this year under the aegis of clearing corporations.

• RBI will do away with charges for NEFT and RTGS payments to encourage digital payments with the caveat that banks must pass on this benefit entirely to the customers.

RBI has done a tightrope walk between the growth needs and the practical realities. The markets will take some time to absorb the significance of rate cut to 25 bps and changing the stance to accommodative. The MPC has shown courage to shift to accommodative stance after 3 rate cuts in the last 4 months. That may be the key takeaway!