SBI Ecowrap: RBI policy delivers no surprise

The monetary policy committee (MPC) decided to cut Repo rate by 25 bps to 6.0% by 4-2 vote. After a long time Repo rate is at this level (earlier between Sep’10 to Nov’10 repo rate was 6%). MPC has retained FY18 GVA growth rate at 7.3%, with balanced risks while committing to keep CPI inflation close to 4% on a durable basis.

We are confident of a benign inflation trajectory going forward and share the MPC view that most of the upside risks to inflation have not materialized. Though implementation of farm loan waiver is a risk for inflation according to MPC, we believe that this will not impact inflation and bond yields as very few States are eligible for additional market borrowings (as per 14th finance commission) in FY18 and also they are accommodating loan waiver amount by reducing expenditure (particularly capital expenditure) without any fiscal slippages."

At this point of time, three things make us more confident of RBI delivering further rate cuts during the year, ceteris paribus.

First, the resolutions of monetary policy committee have now started elaborating more and more about the growth of the various sectors of the economy. Beginning from the last policy every sector, viz. agriculture, industry and services has been analysed in a detailed manner and growth concerns have been suitably highlighted. Perhaps, this weightage being accorded to sectoral growth from the last policy was a signal of the rate cut done today and may be again a harbinger going forward.

Second, coming to the observations on real interest rates, the markets may not be aware that RBI in its 2015-16 Annual Report had indicated that the risk free natural real interest rate for Q4 FY15 was in the range of 0.6% to 3.1%. Against this background, it is very likely that the last RBI assessment of 1.25% real rate may have further declined from such levels, given that growth is weak (real rate is business cycle sensitive). Also given the fact that RBI has reduced Repo rate to 6.0% and will keep CPI inflation at 4% on a longer-term, real interest rate would be around 2%, which is at least 75 bps higher than the earlier estimate. From this point of view also, RBI has indeed room to cut rates, even if it decides to keep real rates at a higher level.

Third, while the nominal GDP of US may have picked up after a dip in Q1, the underlying global conditions are still uncertain regarding growth outlook. Given this, RBI may have window to cut rates, if inflation goes as per the script.



The report has been authored by Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI.

Read the complete report here

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