RBI Monetary Policy Highlights Feb 2020

RBI Monetary Policy Key Takeaways (6th February 2020)

Introduction

Reserve Bank of India (RBI) in its sixth Bi-monthly monetary policy meet of FY2019-20, decided to keep repo rate unchanged to 5.15% on 6th February 2019. RBI decided to continue with the Accommodative stance of monetary policy and projected FY21 GDP growth projections at 6%. Lets discuss the key highlights of Feb 2020 monetary policy in detail.

RBI Monetary Policy Highlights Feb 2020 – Repo Rate Kept Unchanged

• On the basis of an assessment of the current macroeconomic situation, the Monetary Policy Committee (MPC) at its 6th Bi-monthly meeting on 6th February, 2019 decided to keep the policy repo rate unchanged at 5.15%.
• The MPC also decided to maintain Status quo and thus continue with the Accommodative stance of monetary policy as long as it is necessary for reviving growth.
• These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth.

RBI decided to keep Repo Rate unchanged at 5.15%

• On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its 6th Bi-monthly meeting on 6th February, 2020 decided to keep the policy repo rate unchanged at 5.15% for the second time on account rising inflation concern.
• In Dec-2019, retail inflation (CPI) of 7.35% has crossed RBI’s medium-term target inflation of 4% with band +/-2%. So, RBI’s primary concern is to address the rising Inflation first.
• Consequently, the reverse repo rate remains unchanged at 4.90% and the Bank Rate at 5.40%.
• In 2019, the RBI has cut repo rate by 135 basis points so far to a nine-year low of 5.15%

RBI to Continue with the Accomodative Stance & Maintain Status quo

• RBI has decided to continue with the Accomodative stance of monetary policy as long as it is necessary to revive growth.
• It is prudent to remain accomodative as stated by MPC. In the second bi-monthly policy review of FY20 held in June 2019, MPC had changed the monetary policy stance from neutral to accomodative.
• Economic activity remains subdued and the few indicators that have moved up recently are yet to gain traction in a more broad-based manner. Given the evolving growth-inflation dynamics, the MPC felt it appropriate to maintain status quo
• A significant weakening of growth impulse, slowdown in investment activity and a continuous moderation in private consumption growth is a matter of concern, as noted by MPC.
• On account of the slowdown in the above mentioned macroeconomic indicators, RBI sees scope to accommodate growth by supporting efforts to boost demand and re-energize the private investment activity.

FY21 GDP Projection at 6%

• GDP growth for FY21 is projected at 6% in the Feb-20 policy on account of weakening of both domestic and external demand conditions.
• In the last MPC meet (Dec-19), GDP growth was revised to 5% in for FY2019-20. GDP growth for Q2: FY2019-20 slumped to 4.5%, the lowest in more than 6 years.
• GDP growth projections are in the range of 5.5-6% for H1: FY2020-21 and 6.2% for Q3 FY2020-21 with risks evenly balanced.
• Several measures announced by the Government to boost growth :
  • Corporate Tax Rate Cut
  • Withdrawal of Higher Surcharge on sale of Equity by FPIs as well as domestic investors
  • No Tax on Buyback of shares announced prior to 5th July, 2019
  • Removal of Dividend Distribution Tax (DDT) in the recent Budget Feb 2020
• The above measures are expected to revive sentiment and spur domestic demand, especially private consumption in coming quarters.

Revision in CPI Inflation

• RBI has revised Consumer Price Index (CPI) inflation upwards :
• Q4: FY2019-20 at 6.5%
• H1: FY2020-2 in the range 5.4-5%
• Q3: FY2020-21 at 3.2%, with risks evenly balanced.
• Following are the key driving factors which are taken into consideration by MPC for the revision in CPI forecast :
  1. Rise in food inflation on account of upsurge in prices of vegetables (onions) and incipient price pressure in other food items like milk, pulses, sugar.
  2. Volatile Crude-oil prices due to Geo-political tensions in Middle East
  3. Near-term Price pressures due to volatile currency

Transmission Process

• The success of the accommodative policy would depend entirely on the transmission of the lower rates to the ultimate borrowers. Thus the key determining factor of expected favourable results of earlier 135 points repo rate cut by RBI is the effective cascading of the benefits of lower base rate by the banks. 
• In simple words, when RBI cuts repo rate, banks should immediately cut the interest rates of the loans. Interest rates of home loans, vehicle loan or business loans should be come down hand-in-hand.
• RBI is focusing on quick transmission of lower interest rates to the borrowers, issuing loans from the banks. RBI has already made it mandatory for the banks to link the interest rates on loans to the repo rate.

Other Development & Regulatory Policy Measures by RBI

RBI set out various developmental and regulatory policy measures.

1.Improving credit flows to certain sectors

• RBI is actively engaged in revitalizing the flow of bank credit to productive sectors having multiplier effects to support impulses of growth.
• As a part of this, it has now been decided that scheduled commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as retail loans for automobiles, residential housing and loans to micro, small and medium enterprises (MSMEs), over and above the outstanding level of credit to these segments as at the end of the fortnight ended January 31, 2020 from their net demand and time liabilities (NDTL) for maintenance of cash reserve ratio (CRR). This exemption will be available for incremental credit extended up to the fortnight ending July 31, 2020.
• It has been decided to permit extension of date of commencement of commercial operations (DCCO) of project loans for commercial real estate, delayed for reasons beyond the control of promoters, by another one year without downgrading the asset classification, in line with treatment accorded to other project loans for non-infrastructure sector. This would complement the initiatives taken by the Government of India in the real estate sector.

2.Reinforcing monetary transmission

• Operation Twist is a mechanism used to bring more monetary policy transmission
• All new floating rate personal or retail loans and floating rate loans to micro and small enterprises (MSEs) extended by banks were linked to external benchmarks :
  1. Policy repo rate or
  2. Any benchmark market interest rate produced by the Financial Benchmarks India Private Ltd. (FBIL), including Treasury bill rates effective October 1, 2019
• Subsequent to the introduction of an external benchmark system, the monetary transmission has improved to the sectors where new floating rate loans have been linked to the external benchmark.

3.Strengthening regulation and supervision : Laws to strengthen Co-operative banks

4.Broadening and deepening financial markets

• Currently, market makers undertaking rupee interest rate derivative (IRD) transactions with non-residents by way of ‘back-to-back’ arrangements are required to recognize all rupee IRD transactions undertaken by their related entities globally, in their books in India.
• This arrangement is proposed to be extended to cover all market makers, whether or not they undertake back-to-back transactions. It is accordingly proposed that all rupee IRD transactions of market makers and their related entities globally, shall be accounted for in India.
• The measure would encourage higher non-resident participation, enhance the role of domestic market makers in the offshore market, improve transparency, and achieve better regulatory oversight. The revised draft directions shall be issued by end-March 2020.

5.Improving payment and settlement systems

• Reserve Bank will put in place a framework for establishing a self regulatory organisation for the digital payment system by April 2020 with a view to fostering best practices on security, customer protection and pricing, among others.
• The Cheque Truncation System (CTS), which is currently operational at the major clearing houses of the country, has stabilized well and it has made large efficiency gains. In view of this, a pan India CTS will be made operational by September 2020.

Conclusion

• We expect RBI to retain the Accommodative stance in the coming MPC meets in 2020 for supporting growth.
• The inflation outlook is highly uncertain at this juncture. Elevated and rising trajectory of CPI inflation through Q4 FY2019-20 (projected at 6.5%) is currently a crucial concern which is putting the constraints on more repo rate cut by RBI in upcoming MPC meet.