The RBI move follows a deceleration in credit growth to the retail sector and the move is expected to channelise credit to areas where demand has not met with commensurate supply.

The Reserve Bank of India’s Monetary Policy Committee Thursday kept the key policy rate unchanged while admitting that inflation was on a rising trajectory through the fourth quarter of 2019-20 and its outlook remains “highly uncertain.”

In a bid to boost flow of bank credit to productive sectors in a sluggish economy, the central bank also announced a cash reserve ratio (CRR) exemption on incremental retail loans in the automobile, housing and the micro, small and medium enterprises (MSME) sectors until July 31, 2020.

Currently, banks are supposed to keep four per cent of deposits with the RBI as CRR which doesn’t carry any interest. The RBI move follows a deceleration in credit growth to the retail sector and the move is expected to channelise credit to areas where demand has not met with commensurate supply.

While announcing the previous monetary policy on December 5, the RBI had indicated that there is monetary policy space for future action after considering the fiscal measures in the Budget and getting more clarity on inflation.

Unveiling the sixth Monetary Policy Statement for 2019-20 on Thursday, the RBI Committee said inflation has surged above “the upper tolerance band” around the target in December 2019, primarily on the back of the unusual spike in onion prices. The panel noted that over the coming weeks and months, while onion prices are likely to ebb as supply conditions improve, the salutary effects on headline inflation are, however, likely to be tempered by hardening of prices of other food items, notably those of pulses.

“While this decision (status quo on rates) may be on expected lines and perhaps widely discounted, it is important not to discount the RBI… It has to be kept in mind that the central bank has several instruments at its command that it can deploy to address the challenges that the Indian economy currently faces in terms of the sluggishness in the growth momentum,” RBI Governor Shaktikanta Das said.

Maintaining a dovish tone, Das said there is “policy space available for future action” although economic activity remains subdued and the few indicators that have moved up recently are yet to gain traction in a more broad-based manner”.

Following the RBI’s move to ease credit flows, commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as retail loans for automobiles, residential housing and loans to MSMEs, over and above the outstanding level of credit to these segments as of the fortnight ended January 31, 2020 from their net demand and time liabilities (NDTL) — or deposits — for maintenance of CRR.

In other words, loans to these sectors can be deducted from the amount to be kept with the RBI as CRR.

The RBI move follows a deceleration in credit growth to the retail sector. “Alongside sustained efforts to improve monetary transmission, the Reserve Bank is actively engaged in revitalizing the flow of bank credit to productive sectors having multiplier effects to support impulses of growth,” the RBI said.

Bankers said CRR exemption for incremental lending to auto, residential housing, MSME is a good way to channelise credit in areas where demand has not met with commensurate supply. “The exemption of CRR maintenance for all additional loans given for retail loans will also help to lower cost of funds. Extending the date of restructuring of MSME advances will also help the sector to navigate the current business downturn and is a logical corollary of budget announcement,” SBI Chairman Rajnish Kumar said.

The RBI also decided to introduce long-term repo operations to facilitate the transmission of monetary policy actions and flow of credit to the economy.

Das said the government has utilised “escape clause” under the Fiscal Responsibility and Budget Management (FRBM) Act which provides a 50 bps leeway for relaxation of fiscal deficit roadmap during time of stress. It has budgeted a net borrowing Rs 5.45 lakh crore from the market in FY21. “There is no plan to monetise the government’s fiscal deficit,” Das said.

The RBI MPC said the higher fiscal deficit in 2019-20 has not resulted in an increase in market borrowings compared to the budget estimates. The fiscal deficit of the Central Government for 2019-20 is placed at 3.8 per cent of GDP in the revised estimates as against 3.3 per cent of GDP in the budget estimates. The fiscal deficit is budgeted to decline to 3.5 per cent of GDP for 2020-21.

The RBI’s medium-term target for consumer price index (CPI) inflation is 4 per cent within a band of plus or minus 2 per cent, while supporting growth. The MPC decided to keep the policy repo rate unchanged at 5.15 per cent and “persevere with the accommodative stance as long as necessary to revive growth, while ensuring that inflation remains within the target”.

Food inflation rose to double digits, primarily caused by a spike in onion prices due to unseasonal rains in October-November. Prices of several other food sub-groups such as milk, pulses, cereals, edible oils, eggs, meat and fish also firmed up. Fuel prices moved out of deflation. Inflation in CPI excluding food and fuel (or core inflation) continued to edge up from its October trough.

The RBI panel has revised the consumer price inflation (CPI) projection upwards to 6.5 per cent for fourth quarter of 2019-20 as against 5.1-4.7 per cent for the second half of 2019-20. Retail inflation, measured by the CPI, surged to 7.4 per cent in December, the highest reading since July 2014.

The panel on Thursday projected the GDP growth for 2020-21 at 6.0 per cent – in the range of 5.5-6.0 per cent in the first half and 6.2 per cent in the third quarter — as against 5 per cent estimated for 2019-20. In the December 2019 policy review, the RBI’s policy panel, which retained the Repo rate at 5.15 per cent, sharply slashed its GDP growth estimates for the fiscal year 2019-20 to 5 per cent from 6.1 per cent earlier, citing weak domestic demand, further slowdown in global economic activity and geo-political tensions. The government had said the GDP growth in September 2019 quarter had plunged to 4.5 per cent, the lowest since the three months ended March 2013.

“Even though the present monetary policy decision is constrained by elevated inflation pressures, there are other ways in which the RBI can strive to revive growth,” Das said.

Das said that economic activity remains subdued and the few indicators that have moved up recently are yet to gain traction in a more broad-based manner. “This space needs to be used appropriately and should be suitably timed to optimise its impact on growth. Although monetary policy action is constrained at this juncture by the inflation outlook, these pressures should ease going forward,” he said while addressing a media conference.

While the RBI has cut repo rate by 135 points in calendar year 2019, transmission to the credit market has not kept pace. The one-year median marginal cost of funds-based lending rate (MCLR) declined by 55 bps during February 2019 and January 2020. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 69 bps and the WALR on outstanding rupee loans by 13 bps during February-December 2019.