RBI PolicyIn its sixth bi monthly Monetary Policy Committee (MPC) meeting today, Reserve Bank of India has reduced the Repo Rate by 25 basis points (1 basis point is 1/100th of a percentage point). The MPC decided to cut repo rate on 4:2 vote. Four of the six-member MPC, Ravindra H. Dholakia, Pami Dua, Michael Debabrata Patra (RBI executive director) and Shaktikanta Das (RBI governor) voted in favour of the decision, while the other two members Chetan Ghate and RBI deputy governor Viral V. Acharya voted to keep the policy rate unchanged.

However, the decision to change monetary policy stance from “Calibrated Tightening” to “Neutral” was an unanimous one. The street was at the most expecting a change in policy stance, while the repo rate cut came in a surprise.

This is Das’s first policy after he, an ex-bureaucrat and a key member of PM Narendra Modi’s demonetisation execution team, took over as the governor of the central bank after Urjit Patel resigned from the post in December 2018.

The RBI said that the decisions are in tandem with its objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth.

The last time the RBI cut repo rate was in August 2, 2017, when the then RBI Governor Urjit Patel, RBI Deputy Governor Viral Acharya and members Chetan Ghate and Pami Dua voted for a 25 bps rate cut to 6%.  Then Michael Patra and Ravindra Dholakia voted against a rate cut.

Key Rates February 2019

Rate Status Current Value
Repo Rate Changed 6.25%
Reverse Repo Rate Changed 6%
 CRR Unchanged 4%
MSF Rate Changed 6.50%
Bank Rate Changed 6.50%
SLR Unchanged 19.25%

What it means for you

In February 2017, RBI had changed policy stance from accommodative to neutral and later to calibrated tightening. Today RBI changed the stance to neutral again and also has provided a repo rate cut. This means in coming months liquidity will be adequate and also lending rates in the economy would go down. Of course transmission of rate cute in banking system would take some time but your existing loan rates (floating) could potentially reduce.

From an EMI perspective, a borrower’s EMI will depend on three factors – the bank’s MCLR, mark-up and the reset date. A 25 bps rate cut on a 20-year home loan of Rs 40 lakh at 8.85% will bring down the interest payable from Rs 45.4 lakh to Rs 43.9 lakh at 8.6%. This is a savings of Rs 1.5 lakh over the loan tenure.

Many feel that the current rate cut cycle is not going to be a deep one. This is because there are multiple upside risks to the RBI’s inflation projection which if materialises will reduce market expectations of any further rate cut.

However, NBFCs will surely benefit from the current rate cut especially after the IL&FS and DHFL related worries. Resulting in lower cost of funds would help the NBFC sector to recover faster and its positive effects would trickle down to the larger sections of the economy namely real estate and MSMEs.

Bond yields come down

This rate cut seems to be factored in by the market already. 10-year government bond yield was trading at 7.55-7.60 levels at the beginning January month and is trading at 7.30 to 7.35% levels as on today. Mutual Funds having higher modified duration would have been benefitted from this yield movement.

List of Funds having high Modified Duration as on December 2018.

Here are some of the funds in the industry that are currently running high duration:

Scheme Name Modified duration Dec-18 (Yrs)
Quant Dynamic Bond 8.1
IDFC Dynamic Bond Fund 6.3
Reliance Dynamic Bond Fund 5.7
HSBC Flexi Debt Fund 5.4
Baroda Dynamic Bond Fund 5.0
L&T Flexi Bond Fund 4.9
Union Dynamic Bond Fund 4.6
Aditya Birla Sun Life Dynamic Bond Fund 4.5
BNP Paribas Flexi Debt Fund 4.3
UTI Dynamic Bond Fund 4.0

The other key observations by RBI in its policy statement

Global Economy: Global economy slowed down since last policy meeting in December 2018. Among US, Euro zone shown signs of weakness while Japanese economy is recovering slowly – accommodative policy stance in Japan is likely to help the economic growth by improving domestic expenditure.

Some major emerging economies have also slowed down. Growth decelerated in China & Russia while Brazil remained strong. Recovery is gradually happening in South Africa.

Domestic Economy: Domestic economy seems to be moving at a moderate pace. High-frequency indicators of the services sector like sale of motorcycles & tractors, sale of passenger cars, air traffic etc suggest some moderation in the pace of activity. Industrial activity, measured by the index of industrial production (IIP), slowed down in November. The year-on-year (y-o-y) growth in core industries decelerated to 2.6 per cent (y-o-y) in December. Capacity utilisation (CU) in the manufacturing sector increased to 74.8 per cent in Q2 from 73.8 per cent in Q1.

Inflation: Retail inflation, measured by y-o-y change in the CPI, declined from 3.4 per cent in October 2018 to 2.2 per cent in December. This is the lowest CPI print in the last eighteen months. Thanks to continuing deflation in food items, a sharp fall in fuel inflation and some reduction in inflation excluding food and fuel contributed to the decline in headline inflation.

Liquidity: Currency in circulation expanded sharply during December and January. Owing to high liquidity supply by RBI via OMOs.

Net FDI flows to India during April-November 2018 were higher than a year ago. Foreign portfolio flows turned negative in January 2019, after rebounding in November and December 2018. India’s foreign exchange reserves were at US$ 400.2 billion on February 1, 2019.

Outlook on Inflation and Growth: CPI inflation is revised downwards to 2.8 per cent in Q4:2018-19, 3.2-3.4 per cent in H1:2019-20 and 3.9 per cent in Q3:2019-20. This is the lowest inflation projection RBI has given since the central bank started inflation targeting. Food inflation that contributes to ~50% to CPI is expected to remain soft. The policy statement says “Several food groups are experiencing excess supply conditions domestically as well as internationally. Hence, the short-term outlook for food inflation appears particularly benign, despite adverse base effects.”

The GDP growth projections were maintained at 7.4% for the year. RBI said “Looking beyond the current year, the growth outlook is likely to be influenced by the following factors. First, aggregate bank credit and overall financial flows to the commercial sector continue to be strong, but are yet to be broad-based. Secondly, in spite of soft crude oil prices and the lagged impact of the recent depreciation of the Indian rupee on net exports, slowing global demand could pose headwinds. In particular, trade tensions and associated uncertainties appear to be moderating global growth.”

(With inputs from Rahul Sharma)

Priyanka Bharati

Priyanka Bharati is a senior personal finance analyst with RupeeIQ. She can be reached on priyanka.bharati@rupeeiq.com