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Cites elevated inflation path, subdued economic activity
Mumbai, February 6, 2020
The Reserve Bank of India (RBI) today kept its key policy repo rate under the liquidity adjustment facility (LAF) unchanged at 5.15 per cent in view of the elevated path of inflation, on the one hand, and the subdued economic activity, on the other.
Consequently, the reverse repo rate under the 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 RBI said in its Sixth Bi-monthly Monetary Policy Statement, 2019-20 on the basis of the resolution of its Monetary Policy Committee (MPC) at the end of its meeting here today.
The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
"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.
The RBI had kept the repo rate unchanged at 5.15 per cent in its Fifth Bi-monthly Monetary Policy Statement 2019-20 on December 5, 2020 after decreasing it from 6.50 per cent to 5.15 per cent in the previous five statements between February 7, 2019 and October 4, 2019.
The MPC noted that, in its 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, it said.
"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," the resolution said.
The MPC also said that crude oil 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.
"Third, there has 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. Fourth, domestic financial markets remain volatile reflecting both global and domestic factors, which may have an influence on the inflation outlook. Fifth, base effects would turn favourable during Q3:2020-21. Sixth, 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," it said.
Turning to the growth outlook, the MPC said real GDP growth for 2019-20 was projected 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 of trade 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. Fourth, the rationalisation of personal income tax rates in the Union Budget 2020-21 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," the resolution said.
The MPC noted that inflation has surged above the upper tolerance band around the target in December 2019, primarily on the back of the unusual spike in onion prices. Over the coming weeks and months, onion prices are likely to ebb as supply conditions improve. The salutary effects on headline inflation are, however, likely to be tempered by hardening of prices of other food items, notably those of pulses and proteins. Meanwhile adjustments to telecom charges are imparting cost-push pressures to CPI inflation excluding food and fuel.
"Going forward, the trajectory of inflation excluding food and fuel needs to be carefully monitored as the pass-through of remaining revisions in mobile phone charges, the increase in prices of drugs and pharmaceuticals and the impact of new emission norms play out and feed into inflation formation. The MPC anticipates that the combination of these factors may keep headline inflation elevated in the short-run, at least through H1:2020-21. Overall, the inflation outlook remains highly uncertain. Accordingly, the MPC will remain vigilant about the potential generalisation of inflationary pressures as several of the underlying factors cited earlier appear to be operating in concert.
"At the same time, the MPC observes that the economy continues to be weak and the output gap remains negative. While some high-frequency indicators have turned around and point to a lift in the momentum of economic activity, there is a need to await incoming data to gauge their sustainability. Financial flows to the commercial sector have improved in recent months. The Union Budget 2020-21 has introduced several measures to provide an impetus to growth. While the emphasis on boosting the rural economy and infrastructure should help the growth momentum in the near-term, the corporate tax rate cuts of September 2019 should help boost the growth potential over the medium-term. The fiscal deficit of the Central Government for 2019-20 is placed at 3.8 per cent of GDP in the revised estimates as against 3.3 per cent of GDP in the budget estimates. The higher fiscal deficit in 2019-20 has not resulted in an increase in market borrowings compared to the budget estimates. The fiscal deficit is budgeted to decline to 3.5 per cent of GDP for 2020-21. Fresh gross market borrowings are budgeted to increase by ₹70,000 crore to ₹7.8 lakh crore in 2020-21 from ₹7.1 lakh crore in 2019-20. The MPC notes that while there is a need for adjustment in interest rates on small saving schemes, the external benchmark system introduced from October 1, 2019 has strengthened monetary transmission. These developments should amplify the effects of the cumulative policy rate reductions undertaken by the Reserve Bank since February 2019 and pull up domestic demand going forward.
"The MPC recognises that there is policy space available for future action. The path of inflation is, however, elevated and on a rising trajectory through Q4:2019-20. The outlook for inflation is highly uncertain at this juncture. On the other hand, 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. Accordingly, the MPC decided to keep the policy repo rate unchanged and persevere with the accommodative stance as long as necessary to revive growth, while ensuring that inflation remains within the target," the resolution added.
All six members of the MPC -- Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Janak Raj, Dr. Michael Debabrata Patra and RBI Governor Shaktikanta Das voted in favour of the decision.
The minutes of the MPC’s meeting will be published by February 20, 2020. The next meeting of the MPC is scheduled during March 31, April 1 and 3, 2020.