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Tuesday, September 22, 2020

Explained: Two reasons why RBI did not cut interest rates, contrary to expectations

CPI inflation is rising, and has breached the central bank's medium-term target. And the MPC has already cut repo rate by 115 basis points over the course of the last seven months

Written by Anil Sasi , Edited by Explained Desk | New Delhi | Updated: August 7, 2020 8:19:18 am
On the broad outlook, Shaktikanta Das said the global economic activity remains fragile, even as financial markets have been buoyant. (File/Express Photo by Nirmal Harindran)

The Reserve Bank of India’s Monetary Policy Committee (MPC) has unanimously decided to keep the repo rate unchanged at 4 per cent.

While Governor Shaktikanta Das said the RBI’s accommodative stance continues, the holding of rates runs counter to broad market expectations that the central bank would slash policy rates to enable banks to lend more funds to customers.

Alongside its decision to hold rates, the central bank also announced a major restructuring package for stressed MSME loans (rescheduling of loans scheme), which banks and NBFCs have been strongly pitching for given the mounting concerns on the bad loans front. A panel will be set up to draw up the details of this scheme.

Why did the RBI not cut rates?

Given that the Indian economy is still grappling with fresh localised lockdowns to control the Covid-19 spread, and the continuing concerns over demand, especially in sectors such as residential real estate and consumer durables, there was increased expectation that the RBI will further cut policy rates by another 25 basis points (one basis point is one-hundredth of a percentage point) to stoke growth.

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There could be two main reasons why the MPC did not cut rates.

One, retail inflation, measured by the Consumer Price Index, rose in June to 6.09 per cent from 5.84 per cent in March, breaching the central bank’s medium-term target range of 2-6 per cent. That seems to have been a major red flag, which prompted the MPC’s unanimous decision to refrain from cutting policy rates.

Das specifically flagged concerns over domestic food inflation remaining elevated, even as he mentioned that agriculture sector prospects have improved with the good monsoon and the rise in the kharif sowing area.

Also in Explained | How are inflation rate and interest rate linked?

Two, in May, the MPC had cut the repo rate by 40 bps to 4 per cent, while maintaining its accommodative policy stance. In effect, during the course of the last seven months, the MPC has already slashed the repo rate by 115 bps amid the COVID-19 outbreak and consequent economic fallout, even as transmission by banks to customers is still to kick in fully.

On the broad outlook, Das said the global economic activity remains fragile, even as the financial markets have been buoyant. Real GDP growth will remain in the negative, he said, even as “any positive news on the COVID-19 containment efforts would change this scenario”.

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