On December 5, 2019, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) unanimously voted in favour of leaving the policy rate unchanged at 5.15 per cent, against consensus expectations for a 25 basis points (bps) cut. The MPC maintained its accommodative policy stance. The RBI lowered its GDP growth projection for FY20 to 5 per cent Year-on-Year (Y-o-y) from earlier 6.1 per cent. The RBI also raised its headline CPI inflation projection to 5.1-4.7 per cent in H2 FY20 (from 3.5-3.7 per cent). The MPC’s decision was primarily based on the expectation of a spike in inflation in the near term and the need for higher transmission of rate cuts. Post policy, the yield curve along with papers across the maturity curve moved up.
Since February the RBI has reduced interest rates by 135bps. The intent to lower the rates was to boost lending activity in the country and to kickstart the economy. Lower rates lead to higher borrowing and more consumption. However, the transmission of interest rates has been a problem for the RBI. The interest rate transmission by the banks has been limited during the period from January to September 2019. The weighted average lending rates (WALR) of outstanding loans have increased by 5 bps during the review period. The WALR on fresh loans recorded a decline of 39 bps.
Retail inflation rose to a three-year high of 5.56 per cent in November 2019. Breaching the mid-point of the MPC’s medium term inflation target of four per cent (+/-2%) for the second consecutive month. Inflation is likely to remain at elevated levels for the next few months due to a low base effect, unseasonal rains and rise in food prices. A rate cut by the RBI will be contingent upon the inflation trajectory and the likely expenditure or spending announcements that are to be made in the forthcoming Union Budget.
It would be prudent for investors to stay invested in short maturity instruments or funds. There are market participants expecting a rate cut in February or April 2020. This, however, would be contingent upon the inflation data and Union Budget. The markets would remain volatile during this period. The fiscal deficit numbers are expected to be higher. Investors should not take duration risk at this point. Once inflation, particularly food inflation comes off, it would be a good entry point.