RBI keeps repo rate unchanged at 5.15% as inflation spikes

Consequently, the reverse repo rate under RBI’s liquidity adjustment facility (LAF) remains unchanged at 4.90 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 5.40 per cent.

The MPC said it would continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.

RBI said it would ensure that these decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth.

Consumer price inflation, which RBI relies on for measuring inflation, surged 4.6 per cent in October 2019 to 5 per cent in November and further to 7.4 per cent in December, hitting the highest level since July 2014. While food group inflation rose to double digits, the fuel group moved out of deflation. Inflation in CPI excluding food and fuel continued to edge up from its October trough.

CPI food inflation increased from 6.9 per cent in October to 12.2 per cent in

December, primarily due to a spike in onion prices following unseasonal rains in October-November. Excluding onions, food inflation would have been lower by 4.7 percentage points and headline inflation by 2.1 percentage points in December. In addition, inflation in several other food sub-groups such as milk, pulses, cereals, edible oils, eggs, meat and fish also firmed up.

Households’ inflation expectations eased in the January 2020 round of the Reserve Bank’s survey – after a sharp pick-up in the previous round – with the 3-month ahead and 1-year ahead inflation expectations falling by 60 basis points and 70 basis points, respectively.

Based on the Reserve Bank’s consumer confidence survey, consumer spending on nonessential items of consumption contracted from a year ago. However, overall spending is expected to rise, going forward, reflecting an increase in prices, RBI noted. 

The December 2019 round of the Reserve Bank’s industrial outlook survey suggests that the input and output prices of manufacturing firms remained subdued in Q3:2019-20 and are likely to remain so in Q4.

Overall liquidity in the system remained in surplus in December 2019 and January 2020. Average daily net absorption under the liquidity adjustment facility (LAF) amounted to Rs2,61,000 crore in December 2019. In January 2020, the average daily net absorption of surplus liquidity soared to Rs3,18,000 crore. 

The Reserve Bank conducted four auctions involving the simultaneous purchase of long-term and sale of short-term government securities under open market operations (OMOs) for a notified amount of Rs10,000 crore each during December and January (23 and 30 December 2019 and 6 and 23 January 2020).

Reflecting these operations, the 10-year G-sec yield softened cumulatively by 15 bps between 19 December 2019 and 31 January 2020. During the intervening period, however, the yields fell by as much as 25 bps. The weighted average call rate (WACR) traded below the policy repo rate (on an average) by 10 bps in December and by 19 bps in January on easy liquidity conditions.

Monetary transmission across various money market segments and the private corporate bond market has been sizable. As against the cumulative reduction in the policy repo rate by 135 bps since February 2019, transmission to various money and corporate debt market segments up to 31 January 2020 ranged from 146 bps (overnight call money market) to 190 bps (3-month CPs of non-banking finance companies). 

Transmission through the longer end of government securities market was at 73 bps (5-year government securities) and 76 bps (10-year government securities). 

Transmission to the credit market is gradually improving. The 1-year median marginal cost of funds-based lending rate (MCLR) declined by 55 bps during February 2019 and January 2020. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 69 bps and the WALR on outstanding rupee loans by 13 bps during February-December 2019.

After the introduction of the external benchmark system, most banks have linked their lending rates for housing, personal and micro and small enterprises (MSEs) to the policy repo rate of the Reserve Bank. During October-December 2019, the WALRs of domestic (public and private sector) banks on fresh rupee loans declined by 18 bps for housing loans, 87 bps for vehicle loans and 23 bps for loans to micro, small and medium enterprises (MSMEs).

Export growth continued to contract in November-December 2019, reflecting the slowdown in global trade. Import growth slumped in November-December 2019, with contraction in both oil and non-oil non-gold imports. While the latter reflected the underlying weakness in domestic demand and was spread across categories such as transport equipment, coal, iron and steel and chemicals, outgoes on account of oil imports were lower due to a cut back in oil import volume. Gold imports also declined in December 2019. 

On the financing side, net foreign direct investment rose to $24.4 billion in April-November 2019 from $21.2 billion a year ago. Net foreign portfolio investment was of the order of $8.6 billion in 2019-20 (up to 4 February) against net outflows of $14.2 billion in the same period last year. In addition, net investments by FPIs under the voluntary retention route have aggregated $7.8 billion since 11 March 2019. External commercial borrowings were higher at $13.4 billion during April-December 2019 compared with $2.5 billion during the same period a year ago. 

India’s foreign exchange reserves were at $471.4 billion on 4 February 2020 – an increase of $ 58.5 billion over end-March 2019.

In the fifth bi-monthly resolution of December 2019, CPI inflation was projected at 5.1-4.7 per cent for H2:2019-20 and 4.0-3.8 per cent for H1:2020-21, with risks broadly balanced. The actual inflation outcome for Q2 at 5.8 per cent overshot projections by 70 bps, primarily due to the intensification of the onion price shock in December 2019 on account of unseasonal rains in October-November.

Going forward, the inflation outlook is likely to be influenced by several factors. First, food inflation is likely to soften from the high levels of December and the decline is expected to become more pronounced during Q4:2019-20 as onion prices fall rapidly in response to arrivals of late kharif and rabi harvests. Higher vegetables production, despite the early loss due to unseasonal rain, is also likely to have a salutary impact on food inflation. On the other hand, the recent pick-up in prices of non-vegetable food items, specifically in milk due to a rise in input costs, and in pulses due to a shortfall in kharif production, are all likely to sustain.

These factors could impart some upward bias to overall food prices. Also, crude prices are likely to remain volatile due to unabating geo-political tensions in the Middle East on the one hand, and the uncertain global economic outlook on the other. There has also been an increase in input costs for services, in recent months. However, subdued demand conditions, muted pricing power of corporates and the correction in energy prices since the last week of January may limit the pass-through to selling prices. 

RBI noted that, domestic financial markets remain volatile reflecting both global and domestic factors, which may have an influence on the inflation outlook. Also, the base effects would turn favourable during Q3:2020-21. 

Again, with the increase in customs duties on items of retail consumption in the budget may result in only a marginal one-time uptick in inflation. Taking into consideration these factors, and under the assumption of a normal south west monsoon in 2020-21, the CPI inflation projection is revised upwards to 6.5 per cent for Q4:2019-20; 5.4-5.0 per cent for H1:2020-21; and 3.2 per cent for Q3:2020-21, with risks broadly balanced.

RBI had projected GDP growth for 2019-20 in the December 2019 policy at 5.0 per cent – 4.9-5.5 per cent in H2. GDP growth for H1:2020-21 was projected at 5.9-6.3 per cent. For 2020-21, the growth outlook will be influenced by several factors. First, private consumption, particularly in rural areas, is expected to recover on the back of improved rabi prospects. 

The recent rise in food prices has shifted the terms oftrade in favour of agriculture, which will support rural incomes. Second, the easing of global trade uncertainties should encourage exports and spur investment activity. 

The breakout of the coronavirus may, however, impact tourist arrivals and global trade. Third, monetary transmission in terms of a reduction in lending rates and financial flows to the commercial sector has progressed vis-à-vis the last policy, and this could spur both consumption and investment demand. 

Post-Budget, the rationalisation of personal income tax rates should support domestic demand along with measures to boost rural and infrastructure spending. Taking into consideration the above factors, GDP growth for 2020-21 is projected at 6.0 per cent – in the range of 5.5-6.0 per cent in H1 and 6.2 per cent in Q3, RBI stated.