Rate cut in consonance with medium-term CPI inflation objective, says RBI

The Monetary Policy Committee (MPC) decided to cut the repo rate under the liquidity adjustment facility (LAF) by 35 basis points (bps) from 5.75 percent to 5.40 percent with immediate effect.

“The 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 percent while supporting growth,” the Bank’s statement read.

The rate cut, based on an assessment of the current and evolving macroeconomic situation, was announced after the MPC’s meeting on August 7.

The revised reverse repo rate under the LAF now stands at 5.15 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 5.65 per cent. The MPC also decided to maintain the accommodative stance of monetary policy.

Inflation in major advanced and emerging markets remained benign. With its eye on the domestic economy, the RBI noted that retail inflation, measured by year-on-year (YoY) change in the CPI (consumer price index), edged up to 3.2 per cent in June from 3.0 per cent in April-May, driven by rising food prices, even as fuel price inflation and CPI inflation excluding food and fuel prices, moderated.

CPI inflation excluding food and fuel fell by 50 basis points to 4.1 per cent in May from 4.6 per cent in April, and remained unchanged in June.

The statement added, "In the second bi-monthly monetary policy resolution of June 2019, CPI inflation was projected at 3.0-3.1 per cent for H1FY20 and 3.4-3.7 per cent for H2FY20, with risks broadly balanced. The actual headline inflation outcome for Q1FY20 at 3.1 per cent was in alignment with these projections."

The Bank expects the baseline inflation trajectory for the next four quarters to be shaped by several factors. First, the uptick in food inflation may be sustained by price pressures in vegetables and pulses as more recent data suggest. Uneven spatial and temporal distribution of the monsoon could put pressure on food prices, though this risk is likely to be mitigated by the recent catch up in rainfall, which had been lagging.

Second, despite excess supply conditions, crude oil prices are likely to remain volatile due to geopolitical tensions in the Middle East.

Third, the outlook remains soft for CPI inflation excluding food and fuel. Manufacturing firms participating in the industrial outlook survey expect output prices to ease in Q2.

Fourth, one-year-ahead inflation expectations of households polled by the Reserve Bank have moderated.

Taking into consideration all these factors, and the impact of recent policy rate cuts, the path of CPI inflation is projected at 3.1 per cent for Q2FY20 and 3.5-3.7 percent for H2FY20, with risks evenly balanced.

CPI inflation for Q1FY21 is projected at 3.6 per cent.

The MPC also noted that inflation is currently projected to remain within the target over a 12-month-ahead horizon. Since the last policy, domestic economic activity continues to be weak, with the global slowdown and escalating trade tensions posing downside risks.

"Private consumption, the mainstay of aggregate demand, and investment activity remain sluggish. Even as past rate cuts are being gradually transmitted to the real economy, the benign inflation outlook provides headroom for policy action to close the negative output gap," it said.

Addressing growth concerns by boosting aggregate demand, especially private investment, while remaining consistent with the inflation mandate, are the highest priority at this juncture, the Bank assumes.

Also Read: RBI Policy: MPC cuts repo rate by 35 bps to support growth

Also Read: RBI cuts repo rate by 35 bps: Here are 10 takeaways from MPC meet