India unexpectedly cuts key rate, changes stance to neutral

Roman Schwartz
February 7, 2019

The RBI raised rates twice previous year over concerns about rising prices but with inflation now at an 18-month low the bank said it was time to opt for a reduction. "The shift in stance from calibrated tightening to neutral provides flexibility to address, and the room to address, sustained growth of India's economy over the coming months as long as inflation remains benign". In its Febriary 5 report, news agency Reuters had said a softer stance would bode well for Prime Minister Narendra Modi's government, which wants to boost lending and lift growth as it faces elections by May.

It has revised downwards the path of retail inflation to 2.8 per cent in the fourth quarter of the fiscal, 3.2-3.4 per cent in the first half of 2019-20 and 3.9 per cent in the third quarter of 2019-20, with risks broadly balanced around the central trajectory.

Developed economies too are altering stance, with the Reserve Bank of Australia governor this week shifting to neutral.

This was the first meeting of the monetary policy committee (MPC) under Shaktikanta Das who took over as the RBI governor in December after the sudden exit of Urjit Patel over differences with the Modi government.

Analysts say India needs to regularly record growth of at least eight percent to generate employment for the millions entering the workforce each year. The central bank had maintained the status quo in the last two Monetary Policy Committee meetings.

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In its December policy statement, the RBI forecast headline inflation at 3.8 percent to 4.2 percent in the six months starting April, not very far from its medium-term target of 4 percent. "But there should be consistency in views over a period of time".

"On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) chose to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 6.50% to 6.25% with immediate effect", the RBI said in a statement.

Patel's exit prompted some to fret the RBI's independence was under threat, but some economists argued that Thursday's decision should not be read as a surrender to pressure.

The RBI governor said that they expect GDP growth rate to be at 7.4 per cent in fiscal 2019-20 which is up from 7.2 per cent estimated for financial year 2018-19 by central statistical organization. But core inflation - which strips out volatile food and fuel prices - has hovered around 6 percent due to elevated education and medical costs. Previously, it had projected inflation in a range of 2.7 per cent to 3.2 per cent in the six months to March.

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