Monetary Policy combines rate cuts with accommodative stance
The monetary policy announced on 06th June was along expected lines but also disappointed the markets. That was evident from the market reaction on the policy day. However, the RBI has tried its level best to balance growth, liquidity and the realities of the future inflation risks. But first, what were the key highlights of the monetary policy.
Rate cut less than desired
The Monetary Policy Committee (MPC) maintained its dual focus on lowering rates and making liquidity available. Repo rates were cut by 25 bps to 5.75%. This also took the reverse repo rates lower to 5.50% and the MSF cum bank rate to 6.00%. The markets were expecting a bigger rate cut of 35-50 bps but the RBI had its own reasons for the reluctance. Firstly, the first two rounds of rate cuts in February and April had not resulted in proper transmission of the rate cuts to the borrowers. That defeats the purpose of rate cuts. Secondly, the specter of inflation is still a reality and there is already a worry on the monsoon front. IMD and SKYMET have forecast below-average monsoons and that could impact food grain prices and lead to higher inflation. RBI needs to be prepared for that. Lastly, there was the risk that if rates were cut too fast then FPIs may find Indian debt less attractive. That has been one of the most volatile sources of flows and the rupee may not be able to withstand another bout of selling by FPIs.
Focus on stance of the policy
For those traders and analysts who were disappointed by the lower than expected rate cut, there is good news. The RBI has shifted its policy stance from “Neutral” to “Accommodative”. This keeps the doors open for further rate cuts in the future subject to supportive macro data flows. By postponing the rate cut decision to a future date, the RBI also gets the additional benefit of data flows in the form of CPI inflation for 2 more months and a more reliable update on the monsoon progress. These will be key inputs for the RBI to take a view on the rate decision. The real indication is the shift in stance which clearly indicates that the MPC is no longer ambiguous but clear that rates are headed down!
Beyond rates and liquidity
The big takeaway is the move by the RBI beyond rates. Firstly, it has left it to fiscal policy to give the additional thrust. That will be visible in the Union Budget on July 05th. Secondly, the RBI has scrapped its charges to banks for NEFT and RTGS transaction with the caveat that these benefits will be fully passed on. ATM policies will also be reviewed. Above all, the RBI will also make the liquidity ratio more pragmatic and will also ensure that retail investors get an agnostic platform to trade in currencies. The real story of the policy may be actually outside the rates debate!
